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Friday, December 5, 2014

Dynasty Trusts Explained

I am frequently asked about the best way to transfer wealth to younger generations.  Sometimes people feel that absent having a minor child, a problem child or a special needs child, there is no reason to set up a trust.  Often times they are correct and there is no reason create a trust because the client has very responsible children.

Sometimes though, even if the children are quite responsible, if the client has a lot of money, it may be worthwhile to set up a dynasty trust.  Most trusts are designed so that the trust assets will be distributed to the beneficiaries at staggered ages (e.g., one-half at age 25 and the balance at age 30). On the other hand, a dynasty trust is a trust designed to hold assets for many generations usually without any requirement that the principal ever be distributed. 

Keeping assets in trust has many benefits.  If money is in trust it can be protected from creditors, including an ex-wife or an ex-husband.  Additionally, keeping assets in trust will protect it from estate taxes.  (If you give money to a child upon death, it is taxed, when they die, it is taxed again, and so forth...)  

The grantors of the trust can also control the flow of money out of the trust.  For example, they can allow for an income stream, they can allow for small percentage distributions when their heirs reach certain ages or graduate from college, they can allow invasion for certain expenses or they can simply let the trustee decide when and how to give their heirs money based upon whatever criteria they think is important.  The most common standard is for the health, education, maintenance and support of their heirs.

Another beneficial feature of a dynasty trust is that it can be located anywhere.  Typically, wealthy parents have provided for their children and already have good careers and plenty of their own assets.  If parents simply give more money to their children outright, it will be taxed in the jurisdiction where the children live.  If that state has a high income tax, it could be a drain on the funds.  If trust were created in a place that doesn't have a state income tax, that can save significant assets for future generations.

Almost anyone can be trustee of the dynasty trust other than the Grantor.  The Trustee is the party that manages the money and makes distribution from the trust.  Common choices of trustee include the heirs of the Grantor, a friend or an attorney or a corporate trustee.  If the Trustee is also a beneficiary of the trust, there will have to be restrictions on what the Trustee gives himself (otherwise you lose the tax and asset protection benefits).  Often times a trust is created with substantial flexibility so that an heir can act as trustee with limited invasion, but that heir also can be given the power to hire and fire additional trustees who have much broader discretion to distribute funds.  

A dynasty trust can go on for as long as the Grantor has heirs.  In case something happens to the entire family, most people usually name a charitable remainder beneficiary.  Other features that most good dynasty trusts include are the ability to relocate the trust to another jurisdiction (usually to obtain a more favorable tax rate), the ability to have a separate investment advisor, and the creation of a trust protector to modify terms of the trust in the events facts or circumstances change. 

A dynasty trust can be created during the lifetime of the Grantor (an intervivos trust) or upon his death (as a testamentary trust).  Usually it is better to create the trust during the lifetime of the Grantor because it will offer more flexibility in terms of jurisdiction (where the trust is located).  Jurisdiction is important because some states do not allow a perpetual trust, there is a state income tax in some states, and some states offer better creditor protection than others.  Another benefit to creating a dynasty trust during the lifetime of the Grantor is because the trust can be set up as an Intentionally Defective Grantor Trust (IDGT).

An IDGT is an irrevocable trust created during the Grantor's life that is not includible in the gross estate of the Grantor at the time of his death, but while the Grantor is alive, the income is taxable to the Grantor.  The benefit to this is that the Grantor can pay the taxes on the trust with his own money, allowing the trust to grow at a faster rate.  Essentially, it is like making a tax free gift to the trust in the amount of the tax.

Even if a trust is created during a Grantor's lifetime, it does not have to be funded until the Grantor passes away.  Sometimes a Grantor will want to or need to maintain control over certain assets.  Often, it is best to partially fund the dynasty trust with assets that the Grantor thinks will appreciate substantially in the future and transfer low basis assets that have already highly appreciated to the dynasty trust on death.

Because of the potential that these trusts can go on forever, it should not be set up unless the individuals involved have a fair amount of assets.  Normally I would not recommend it unless the Grantor is planning to fund it with several million dollars.  However, each client's situation is unique. Please contact our attorneys if you think a dynasty trust might be right for you.

Monday, December 1, 2014

Update to Executor's Commissions in NJ

Back in March of 2014, I wrote a lengthy post about how to Calculate an Executor's Commissions in New Jersey.  Frankly, most of the executors I work with don't want a commission.  However, I recently came across an interesting situation where an executor wanted a commission and the decedent had substantial joint survivorship accounts with the executor.

Normally, a survivorship account is not subject to an executor's commission on the theory that the executor doesn't have to do any work with respect to those accounts.  In this situation though, the survivorship accounts were actually convenience accounts.  A convenience account is a type of account that goes to the surviving account holder, primarily to pay bills, but based upon the intent of those involved, the balance of the funds will be disposed of with the rest of the Decedent's estate.  In other words, the money does not legally belong to the surviving joint account holder, it belongs to the estate of the Decedent.

In my situation, even though the money passed to the executor, in his individual capacity, on the death of the decedent, the money will ultimately be processed through the estate's accounts and go to the beneficiaries under the Decedent's Will. Accordingly, the executor CAN take a commission on these joint accounts.  More importantly, this commission is tax deductible for purposes of calculating the New Jersey estate tax.

I had trouble finding legal authority for this position, so I called up the New Jersey Division of Tax, Estate and Inheritance Department, and they confirmed this result.

Monday, November 17, 2014

2015 Update to Federal Estate Tax Exemption

Starting January 1, 2015, the federal estate and gift tax exemption will increase from $5,340,000 per person to $5,430,000.  That is an increase of $90,000.  If you are married, that amount will be doubled.

In addition to the lifetime estate and gift amounts, a person can also give away up to $14,000 per year.  This amount will not change for 2015.


Tuesday, September 30, 2014

Non Residents of Pennsylvania Can Be Subject to Pennsylvania Inheritance Tax

I frequently get calls from individuals who had a relative pass away with property located in Pennsylvania. Even though the decedent lived somewhere besides Pennsylvania, you should be aware that Pennsylvania reserves the right to tax this property on the death of the owner via an inheritance tax.

This tax will apply whether the decedent owned the property outright or in a revocable trust. Moreover, it does not matter where the beneficiaries live.  However, the tax rate for the PA inheritance tax is based upon who receives the property.  So, there will not be a tax if the property is left to a surviving spouse or a charity, but there will be a 4.5% tax if it is left to children.

There are ways to minimize or avoid this tax completely, but often it can come at the cost of paying more in capital gains tax.  If you are a non-resident owner of Pennsylvania real estate, I strongly suggest you meet with an estate planning attorney on how to minimize the taxes on your death.

Monday, August 11, 2014

Non-residents Non-citizens of the US Should Be Careful of How they Invest in American Assets

Many individuals who live outside of America like to purchase real estate in America or invest in the U.S. Stock Market.  It can be much safer than in investing in other parts of the world and often times the individual has children who have moved to America to live or study.

Florida and New York are particularly attractive locations for foreigners to buy vacation homes or rental properties, so I will focus on those jurisdictions a bit.

From a tax perspective, Florida is relatively easy to deal with as there is no estate tax. The transfer taxes are small and the process is pretty quick if you need to transfer the property during your lifetime. New York recently changed its estate tax laws, so that individuals can soon transfer over $5,000,000 before there is a state estate tax.  Transfer taxes are a bit higher and the process is a bit slower, but it is not terrible.

On death, it is a different story, both Florida and New York can be a royal nightmare and you should avoid probate.  Probate is the process of transferring assets on death and is typically quite expensive. It is also very easy to avoid by setting up a simple trust that is invisible for taxing purposes. A trust can also be set up to avoid the US federal estate tax, and I strongly recommend this.

With respect to the US taxes, a foreign investor must worry about both income taxes AND estate taxes.  While owning stock or real estate outright may be easiest and perhaps even best to minimize income taxes, it can be the worst thing to do for estate taxes.

The United States is not very friendly when it comes to foreign individuals who wish to transfer property in America. While a US citizen or resident alien may transfer $5,340,000 before there is a gift or estate tax, the threshold for non-resident is $14,000 for gifts (per person per year) and only $60,000 (total) on death.  A person may gift $145,000 (annually indexed for inflation) to a non-citizen spouse before there is a US gift tax.

For transfers in excess of the limits above, there is an 18%-40% tax depending upon the amount of the transfer.  You can defer the tax on a transfers to a spouse by setting up a Qualified Domestic Trust (QDOT).

Additionally, the rules are very complicated because some assets are taxed on death or gift and some assets are not.  The general rule is that if something can be considered a U.S. Situs asset, it is subject to the US Federal Estate Tax when the owner dies.  Examples of U.S. Situs assets include: real estate located in the U.S., cash or jewelry in the U.S., ownership in a US based REIT, and ownership of a US based Annuity.  Examples of Non-U.S. Situs assets include: real estate in foreign countries and stock in foreign corporations.  Less obviously, this also includes life insurance and debt obligations (such as bonds).

This is further confused by the fact that some assets considered non-U.S. situs for gift tax purposes differ from the assets that are non-U.S. situs for estate tax purposes.  Specifically, intangible property such as stock in a U.S. corporation or an interest in a US partnership or limited liability company are considered U.S. Situs assets for the estate tax, but not the gift tax. Additionally, cash on deposit in a checking or savings account at a U.S. Banking institution is a U.S. situs asset for gift tax purposes, but not for estate tax purposes.

To restate this another way, a gift in excess of $14,000 of cash on deposit in a U.S. bank is subject to a gift tax.   However, regardless how much cash is there when you pass away, it is not subject to the U.S. Estate tax.  Conversely, a gift of U.S. stock (regardless of how much), is not subject to the U.S. Gift Tax, but if you die owning the stock, anything in excess of $60,000 is subject to the estate tax.

(NOTE: a person must be really careful of that cash in a money market account is treated as an intangible asset so it is considered a U.S. Situs asset for estate tax purposes, but not gift tax purposes.) Please see this link to the IRS website which details assets that are subject to the US estate tax and those which are exempt.

If you are a non-resident, non US citizen who owns stock and real estate in the United States, your options include:
1) Paying the estate tax on your death;
2) Setting up a foreign corporation to own a local business entity (this will cause more income taxes now though, but save money on estate/gift taxes);
3) Sell the stock and property before you die and put the money into non-US situs assets until afterwards (this can be tough to time though).
4) Transfer the house to an LLC and then transfer the stock and the LLC to your children or to a trust for your children. As long as you survive for 3 years after the transfer, this should not be an issue for estate tax purposes.
5) Sell the assets and invest the money inside of a life insurance policy. That will be free of income tax and estate tax. The question is whether you can find someone to write the policy on a non-resident.

I generally recommend that if a person can afford it, you establish a US based trust in a state that doesn't have an income tax (like Florida) to own assets. Ideally you should transfer money into the trust from a non-US bank account. If you do not need the income from the trust, you can make the trust strictly for the benefit of your heirs. This will avoid an estate tax on the assets owned by the trust REGARDLESS OF WHAT ASSETS ARE NOW IN THE TRUST. This is how you can invest in the market or in real estate without worrying about an estate tax. As mentioned above trust will also help with administration and managing the funds by avoiding probate.

Remember a gift or transfer of assets may require the need to file an informational return with the IRS.  Also, the United States has tax treaties with several countries which may affect your need to do planning, so please confer with a competent international estate planning attorney before buying any assets in America.


Friday, August 8, 2014

Japanese Inheritance Tax vs. US Estate Tax (2014 Update)

BRIEF OVERVIEW OF
JAPANESE INHERITANCE AND GIFT TAXES
vs.
AMERICAN ESTATE AND GIFT TAXES
(2014 Update)

I. Estate Taxes
A. America
1. If the Decedent is a Citizen or Permanent Resident
a. Tax on Worldwide property (credit for taxes paid to foreign countries)
b. Exemption of $5,340,000 in 2014 (indexed for inflation). For married couples, the exemption amount is $10,680,000 as a result of portability.
c. Federal Estate Tax of 40% on amount over $5,340,000
d. Unlimited Marital Deduction for Surviving Spouse if Surviving Spouse is a citizen
2. If the Decedent is a Non-Citizen/Non-Permanent Resident
a. Tax only on Real Property and business interests in the United States (Cash in foreign banks and foreign stocks are not taxed)
b. Exemption of $60,000 for US based Assets
c. Tax of between 18%-40% on amount over $60,000
d. Unlimited Marital deduction if Surviving Spouse a citizen
e. Tax on bequest to surviving spouse can be delayed by creating a Qualified Domestic Trust
3. If the Decedent is not a United States Citizen or permanent resident alien, assets outside of the US can pass to a US person with no US estate tax.
B. Japan (Actually an Inheritance tax, not an estate tax)
1. Japanese Citizens and Permanent Residents
a. Tax on Worldwide property (credit for taxes paid to foreign countries) - [NOTE - this is new for 2013, previously Japan did not tax worldwide assets] 
b.  Exemption of ¥30,000,000 + (¥6,000,000 for each statutory heir); Possible additional exemption for insurance money, retirement savings, and money left to handicapped individuals [NOTE - this is a reduction from the previous exemption of ¥50,000,000 and ¥10,000,000 per statutory heir.]
c. Additional exemption for life insurance received of ¥5,000,000 multiplied by the number of statutory heirs
c. Until December 31, the highest tax rate is 50%.  Effective January 1, 2015, tax between 10%-55% for statutory heirs (spouse, children and parents) after you go over the exemption amount;
  • Up to ¥10 million 10%
  • Above ¥10 million up to ¥30 million 15%
  • Above ¥30 million up to ¥50 million 20%
  • Above ¥50 million up to ¥100 million 30%
  • Above ¥100 million up to ¥200 million 40%
  • Above ¥200 million up to ¥300 million 45%
  • Above ¥300 million up to ¥600 million 50%
  • Over ¥600 million 55% 
d. An additional 20% surcharge for everyone other else other than charities (this does include a surcharge on gifts to grandchildren);
e. For property outside of Japan, a beneficiary that acquires property will be subject to Japanese inheritance tax. (THIS IS A MAJOR CHANGE, prior to April 1, 2013, Japan did not tax gifts or inheritance of property outside of Japan received by non-Japanese nationals.)
f. A surviving spouse is entitled to a tax deduction. This is a complex formula based upon who is living at the time of the Decedent's death and where the money goes. Generally, a surviving spouse can deduct about 1/2 to 2/3 of the tax.
2. Non-Citizens/Non-Permanent Residents
a. If beneficiary is not Japanese and not living in Japan and property is not in Japan, appears Country where property located will tax such property.
b. I'm currently double checking to see if the Beneficiary is a Japanese Domiciliary whether Japan CAN tax inheritance regardless of where Decedent lived and regardless of where assets are located (subject to tax treaties)
c. If there is a tax, it appears a surviving spouse is entitled to the same marital tax deduction as for Japanese citizens.
3. Real estate acquisition tax is exempt if passing by bequest.  There is a registration and license tax at the rate of 0.4% of the assessed value of the land and building. (currently reduced?)

II. Gift Taxes
A. America
1. Citizens and Permanent Residents
a. Tax on all gift transfers of Worldwide property
b. Annual exemption of $14,000 per person/per donee (unlimited gifts for donees if different donors)
c. An annual gift to a non-citizen, permanent resident spouse, of $145,000 is available.
d. Lifetime exemption of $5,340,000
e. Gifts may be split with spouse
f. Tax rate of 40% if lifetime gifts exceed $5,340,000
2. Non-Citizens/Non-Permanent Residents
a. Tax on all gift transfers of US Property (including real estate and Stocks in US companies)
b. Annual exemption of $14,000 per person/per donee (unlimited gifts for donees if different donors)
c. Annual gift tax exemption if gift to a spouse of $145,000 (Note that a person can gift more to a spouse than they can bequest to a spouse)
c. No Lifetime exemption
d. Gifts may not be split with spouse
e. Tax rate of 18%-40% if gifts exceed $14,000
B. Japan (Rates between 10%-55%)
1. Citizens and Permanent Residents of Japan
a. Tax on gifts of property Worldwide (credit for taxes paid to foreign countries) - [NOTE - this is new for 2013, previously Japan did not tax gifts worldwide assets to certain people] 
a. Annual exemption of ¥1,100,000 for each beneficiary (beneficiary taxed after this)
b. One time spouse exemption of ¥20,000,000
c. Effective January 1, 2015, tax between 10%-55% for statutory heirs (spouse, children and parents) after you go over the exemption amount;
  • Up to ¥2 million 10%
  • Above ¥2 million up to ¥4 million 15%
  • Above ¥4 million up to ¥6 million 20%
  • Above ¥6 million up to ¥10 million 30%
  • Above ¥10 million up to ¥15 million 40%
  • Above ¥15 million up to ¥30 million 45%
  • Above ¥30 million up to ¥45 million 50%
  • Over ¥45 million 55% 
  • The threshold is lower for gifts to other individuals.
d. For property outside of Japan, a donee that acquires property will be subject to Japanese gift tax.  (THIS IS A MAJOR CHANGE, prior to April 1, 2013, Japan did not tax gifts or inheritance of property outside of Japan received by non-Japanese national.)
2. Non-Citizens/Non-Permanent Residents
a. Annual exemption of ¥1,100,000 for each beneficiary(unclear – enforcement is almost impossible)
b. Japan will tax donees who live in Japan.
3. Special real estate acquisition tax of 4% (currently reduced?) in addition to a registration and license tax at the rate of 2% of the assessed value of the land and building.

III. Generation Skipping Taxes (Taxes on gifts or bequests to grandchildren or lower generations)
A. America
1. Exemption of $5,340,000 (indexed for inflation)
2. Tax of 40% on rest
B. Japan
1. None

Remember, there is an estate and inheritance treaty between the United States and Japan to minimize double taxation of assets on death if you own assets in both countries or are a resident of one living in the other country

For more information on Japanese taxes, the Japanese government has a website in English with some helpful facts, but it is now very outdated. 

I am not licensed to practice in Japan, this is just my understanding of Japanese gift and inheritance tax law that I can gather from sources which are written in English.

NOTE- Major rewrite on 9/12/14 to address changes in rates and fact that assets outside of Japan are now subject to Japanese inheritance and gift tax.

Wednesday, July 16, 2014

Duty of Executor to Defend a Will Against a Will Contest in Pennsylvania

In most states, when a person is named as an executor in the Will, the executor has an affirmative duty to defend the Will from Will contests.  For example, if mom dies testate leaving her entire estate to child one, cutting out child number two, and child number two sues to say the Will is result of undue influence, the executor would be obligated to defend the validity of the Will and could hire an attorney using estate assets to aid in the defense.  Unless the executor caused the undue influence, he would not be personally liable to the estate for the cost in defending the validity of the Will.

Pennsylvania law is quite different from most other states in that while an executor is a necessary party to a contest involving the Will, the executor is generally not a party in interest who has standing to instigate a contest or to appeal a decree of distribution. (In re Estate of Fleigle, 664 A.2d 612, 444 Pa Super. 632 (1995))  An executor who has not been surcharged or is not required to distribute an amount larger than the total assets of the estate has no standing to except to an adjudication of the auditing judge regarding payment of claims against an estate unless the executor is also a residuary beneficiary of the estate.  (Appeal of Gannon, 428 Pa. Super. 349, 360-61, 631 A. 2d 176, 181 (1993))  The executor is entitled to notice and may then elect whether to become a party (Royer’s Ap. 13 Pa. 569; Yardley v. Cuthbertson, 108 Pa. 395, 445-448), although if he does become a party his costs and counsel fees must be paid by him or those who authorize him, not by the estate.  (Faust Estate, 364 Pa. 529 (1950))

The Faust case is extremely important because it shifts the burden for payment of legal fees from the estate to the executor personally if the executor decides to insert himself or herself into a Will contest.  Additionally, if executors engage in an act that is beyond their scope as representatives of an estate, they risk losing their executor's commission.

Pennsylvania law does have a few exceptions for when an executor can get involved in a Will contest.  An exception exists where a testator directs or imposes a duty on the executor to defend the Will against contests.  (Bennett Estate, 366 Pa. 232 (1951); See also:  Tutelea Estate, 4 Pa. D. & C. 3d 199 (1974))  Another exception to the Pennsylvania rule is where the executor is also a trustee and is required to defend the trust.  (Fetter's Est., 151 Pa.Super. 32, 29 A.2d 361 (1942)).

We also need to differentiate cases where an executor is being sued for his services as executor.  (Browarsky Estate, 437 Pa. 282 (1970))  Because the executor is placed in the position to be sued because of duties he had performs for the estate, it would be unjust to require him personally to bear the reasonable costs of the defense of suits brought against them solely by reason of their positions as executors. "It is well established that whenever there is an unsuccessful attempt by a beneficiary to surcharge a fiduciary, the latter is entitled to an allowance out of the estate to pay for counsel fees and necessary expenditures in defending himself against the attack [citing cases]." Wormley Estate, 359 Pa. 295, 300-01, 59 A.2d 98, 100 (1948). Accord: Coulter Estate, 379 Pa. 209, 108 A.2d 681 (1954).

Finally, there is very old case that stands for the proposition that: “The executor propounding a Will for probate, acting in good faith, is entitled to costs out of the estate, whether probate is granted or refused.”  (Ammon’s Appeal, 31 Pa. 311).  I note that I can’t find the case, only a cite in a treatise, but I believe this to still be good law if the executor does not get involved in a Will contest.

If an executor uses estate assets to pay for legal fees related to a lawsuit against himself or because the executor impermissibly got himself involved in a Will contest, a judge can surcharge counsel of an estate or counsel for an executor. (Faust)

The rationale behind the Pennsylvania case law is that a Will contest is between the testamentary beneficiary and the heirs or next of kin, therefore the executor should not waste estate assets on their dispute.  The rationale behind the rules in most other states presumes that the testator wrote the Will the way he or she wanted it and the executor should try to uphold the testator's intent.

From a practical point of view of estate administration attorneys, we need to consider three things.  One, we need to understand the source of the money from which we are getting paid and keep track of it. If we are paid from the estate for a Will contest or for an objection to an accounting, we may be required to give the money back to the estate.  Personally, we always ask for a retainer from a proposed executor before they have qualified executor.  Accordingly, they are paying me with their own money and getting reimbursed from the estate later.  Also, attorneys should put language in their retainer agreements stating that the proposed executor is personally liable for the legal work if he cannot qualify as executor or if we wind up doing work for the executor in an individual capacity.

Second, in the event of a Will contest or an objection to an accounting, attorneys should track their time separately.  Time spent on the Will contest or an objection to an accounting should be differentiated from time spent administering the estate.

Finally, attorneys should consider whether they want to draft their estate planning documents in a way to change the default rules regarding an executor's duty to defend the Will.  Personally, I think that it makes more sense for an executor to use estate assets to defend the integrity of a Will and that the executor shouldn't be personally liable absent gross negligence, willful misconduct or bad faith. After all, some beneficiaries might not have the resources or the mental capacity to act in their own best interests.
--------------------
Thanks to Pierson W. Backes, Esq. for his help with this article.

Wednesday, July 2, 2014

Nice Article on the Basics of ILITs

A colleague of mine, David Saltzman, has written a nice article on the Basics of Irrevocable Life Insurance Trusts.  As he points out, setting up a life insurance trust is a great way to minimize your estate tax liability and it can be especially important in New Jersey.

Dave is a great resource and knows a lot about insurance.  Feel free to contact him regarding any insurance questions you may have.

Monday, May 26, 2014

Pennsylvania Same Sex Married Couples No Longer Have to Pay Inheritance Tax

On May 20, 2014, U.S. District Court Judge John Jones III declared that Pennsylvania's laws banning same sex marriage was unconstitutional.  Besides the practical implication that same sex couples in Pennsylvania may now get married, it also means that when one spouse dies, the survivor can now inherit tax free.  

Previously, only a heterosexual surviving spouse could inherit assets of the deceased spouse tax free.  Additionally, for same sex couples, if one partner left money to another, that would be taxed at a 15% rate - the same as if the person were a total stranger.

If you are in a same sex marriage (that was licensed in another state) you may wish to consider revising your estate planning documents as a result of this ruling.  Additionally, if you have recently lost a same sex spouse, you may wish to consider amending the Pennsylvania inheritance tax return to request a refund.   

Thursday, May 22, 2014

Change in New York Estate Tax Law

Effective April 1, 2014, the State of New York made numerous changes to its tax law.  Most dramatically, New York is increasing its estate tax exemption amount from $1,000,000 to match the federal estate tax exemption amount.

New York's New Estate Tax Exemption Amount
Until March 31, 2015, the new estate tax amount will be $2,062,500.
From April 1, 2015-March 31, 2016, the exemption amount will be $3,125,000.
From April 1, 2016-March 31, 2017, the exemption amount will be $4,187,500.
From April 1, 2017-December 31, 2018, the exemption amount will be $5,250,000.
From January 1, 2019 on, the exemption amount will be indexed to the federal estate tax exemption amount.

However, New York has created a devastating Estate Tax "Cliff" by phasing out the benefit of the New York Exclusion Amount for estates that exceed 100% - 105% of the exclusion amount.

The practical implication of the "Cliff" is that for estates under the NY estate tax exemption amount, there will be no tax.  For estates just above the threshhold, there will be an effect tax rate of as high as 252% (Source www.jdsupra.com).  For estates above 105%, there is a flat 16% tax on all assets owned by the decedent, not just the amount above the exemption limit.

Addition of a Three Year Look Back Provision
New York has also added a three year look back provision for gifts made within three years of death.  This provision only applies for gifts made between April 1, 2014 and January 1, 2019.  The lookback will not apply if the gifts were made when the decedent wasn't a New York resident or if the gift is otherwise includible in the decedent's taxable estate.

Other Important Changes to NY Estate Tax
Other major changes made by the new law are to:
1)  repeal New York's generations skipping transfer tax; and
2)  allow a marital deduction for non-citizen spouses.

New Law Regarding Income Taxation of NY Resident Trusts
Finally, the new law aggressively pursues an income tax on trusts for the benefit of New York residents.  The bill is going after two types of trusts.  The first one being one that a wealthy New York resident sets up for his own benefit, retaining a discretionary interest in the trust.  The second one being any trust for the benefit of a New York resident.

With respect to the first type of trust, for years, wealthy individuals have set up "incomplete gift non-grantor trusts" to avoid the New York income tax.  The idea was that if you created a trust in another jurisdiction (with the assets and trustees outside of NY) then New York would not have the right to tax the income earned in that trust to the extent income was retained in the trust.

With respect to all other trusts, New York will now tax the distributions of accumulated income to New York residents.  However, the State will offer a credit to the extent a tax is paid to another jurisdiction.

Important Items That Were Considered But Not Changed
1)  New York has not adopted the concept of portability of the estate tax exemption; and
2)  New York had considered a maximum 10% tax rate, but decided to keep it at 16%.

Friday, March 14, 2014

Excellent Guide on International Estate and Inheritance Taxes

While I have not had a chance to review it thoroughly to confirm its accuracy, I note that the accounting firm, Ernst & Young, has posted a detailed analysis of the estate and inheritance tax laws of almost every country in this brochure.

For those of you who have assets in multiple jurisdictions or are citizens living abroad, you should familiarize yourselves with these laws and hire competent counsel to asset you in minimizing your taxes.

Monday, March 10, 2014

Calculating Trustee Commissions in NJ

From time to time, people ask me how executor's commissions and trustee's commissions should be calculated.  I have already written a post on calculating executor and administrator commissions, so this post will focus on Trustee commissions.

New Jersey statutes on trustee commissions are very difficult to interpret because they use the term fiduciary to apply to executors, administrators, trustees, guardians and conservators.  This would not be a problem if the fees were calculated the same, but they are not.  Additionally, there are different rules for testamentary trusts (trusts created under a Will) and intervivos trusts (a trust created while the Grantor was alive).  Going forward, if a particular rule applies to everyone, I will call that person a fiduciary.

To start, the Grantor of a Trust can specifically provide for a trustee commission.  However, for testamentary trusts, if the commission is higher than the amount allowed under the New Jersey statutes, the Will must specifically state that the testator is aware of the commissions allowed under the New Jersey statutes and expressly authorize payment in excess thereof.  N.J.S.A. 3B: 18-31.

Failure to expressly authorize a commission in excess of the NJ statutory limit or failure to state whether or not a trustee is even entitled to commission will result in the trustee being able to take a fee as provided in New Jersey Statutes 3B:18-23 through 3B:18-29.  These statutes also apply to Guardians and Conservators.

So how is the trustee's fee actually calculated?

Unlike an executor who typically takes a one time fee, Trustees are more likely to take annual commissions, especially if the trust goes on for a long time.

The fee is comprised of both an income commission and a corpus commission.  A trustee is entitled to annual income commissions of 6% without prior court approval. N.J.S.A. 3B: 18-24.

The corpus commission is a bit more complicated to calculate:. Normally an executor will take a one time commission as follows:
  1. 0.5% on the first $400,000 of all corpus received by the executor; plus
  2. 0.3% on the excess over $400,000.  (N.J.S.A. 3B: 18-25)
If there is more than one trustee, an additional 1/5 of all the commissions allowed above is authorized, provided that no one trustee shall be entitled to any greater commission than that which would be allowed if there were but one trustee involved.   (N.J.S.A. 3B:18-25.1)

A trustee is entitled to a minimum fee of at least $100 per year and corporate trustees may set their own rates.  

Upon the termination of a trust, the trustee is entitled to a termination fee in addition to the annual fees he or she may have taken.  3B:18-28.  The termination commission is as follows:
  1. If the distribution of corpus occurs within 5 years of the date when the corpus is received by the fiduciary, an amount equal to the annual commissions on corpus authorized pursuant to N.J.S. 3B:18-25, but not actually taken by the fiduciary, plus an amount equal to 2% of the value of the corpus distributed
  2. If distribution of the corpus occurs between 5 and 10 years of the date when the corpus is received by the fiduciary, an amount equal to the annual commissions on corpus authorized pursuant to N.J.S. 3B:18-25, but not actually received by the fiduciary, plus an amount equal to 1 1/2 % of the value of the corpus distributed;
  3. If the distribution of corpus occurs more than 10 years after the date the corpus is received by the fiduciary, an amount equal to the annual commissions on corpus authorized pursuant to N.J.S. 3B:18-25, but not actually received by the fiduciary, plus an amount equal to 1% of the value of the corpus distributed; and
  4.  If there are two or more fiduciaries, their corpus commissions shall be the same as for a single fiduciary plus an additional amount of one-fifth of the commissions for each additional fiduciary.
An illustration of how to calculate the annual trustee commission

Let's presume the following facts:  Trust owns a house worth $500,000, a $1,400,000 in stocks and bonds, and $100,000 worth of cash. This is the value at the end of the previous year.

Let's also presume that there is only one trustee and in the year in question the stocks and bonds gave off $56,000 of income. 

Accordingly, the calculation would be as follows:

0.5% on the first $400,000 would be $2,000
0.3% on the next $1,600,000 would be $4,800
6% on the $56,000 of income would be $3,360
So the trustee would be entitled to a total commission of $10,160 for the previous year.

Final thoughts about trustee's commissions

Any commission that a trustee takes will be subject to an income tax.  As a result, if the trustee is also a beneficiary, he or she may not want to take a commission.  Additionally, many times relatives do not appreciate the amount of work involved and will become upset at a trustee if he or she takes a commission. You should think about the dynamics of your family before taking one.

A trustee that does extraordinary work can apply to the court for a commission in excess of the statutory fee.  A trustee needs to prepare an annual accounting, and one that fails to adequately communicate with the beneficiary or otherwise behaves badly can be removed by the court.  If a trustee is removed from office, he or she may be required by a judge to forfeit his commissions.  This is not automatic though.

Finally, as discussed in back in May of 2013, an attorney who is serving as a trustee may be entitled to a fee for legal services AND a commission.

Friday, March 7, 2014

Calculating NJ Executor Commissions

From time to time, people ask me about executor's commissions and trustee's commissions in New Jersey.  Because it is a bit complex, I have broken it down into two posts and I will focus on commissions for executors and administrators today.

To start, a Will can specifically provide for an executor's commission.  In that absence of expressly authorizing a commission an executor will be entitled to take an executor's fee as provided in New Jersey Statutes 3B:18-12 through 3B:18-17. These same statutes also provide that if a person dies intestate (dies without a Will), the administrator of the estate may also take a fee.  Since the fees for an executor and administrator are the same, I will use the term interchangeably for purposes of this post.

New Jersey statutes are very difficult to interpret because they use the term fiduciary to apply to executors, administrators, trustees, guardians and conservators.  This would not be a problem if the fees were calculated the same, but they are not. 

So how is the executor's fee actually calculated?

First, an executor is entitled to annual income commissions of 6% without prior court approval. (N.J.S.A. 3B:18-13)

Second is the calculation of the corpus (or principal) commission.  This is a bit more of a complicated formula. Normally an executor will take a one time commission as follows:
  1. 5% on the first $200,000 of all corpus received by the executor;
  2. 3.5% on the excess over $200,000 up to $1,000,000;
  3. 2% on the excess over $1,000,000;
  4. and 1% of all corpus for each additional executor provided that no one executor shall be entitled to any greater commission than that which would be allowed if there were but one executor involved.   (N.J.S.A. 3B:18-14)
Sometimes an estate administration goes on for a lengthy period of time.  Under such circumstances, an executor can also receive an annual commission equal to 1/5 of 1% (or 0.2%) of the corpus.  However, this commission is not that frequently taken and a court may disallow it if it is in excess of  N.J.S.A. 3B:18-14.

What assets are part of the corpus when determining the executor's commission?
The corpus of an estate is generally defined to mean any asset that has come into the hands of the executor.

Examples of assets that come into the hands of the executor are:  Bank accounts, automobiles, tax refunds, business interests, an interest in a lawsuit or litigation, life insurance payable to the estate, retirement accounts with no beneficiary and real estate that were owned by the decedent. 

Examples of assets that do not come into the hands of the executor and are not subject to the commission include: Life insurance (if there is a beneficiary other than the estate), retirement accounts where a beneficiary other than the estate is named, property that is held as joint tenancy by the entirety or joint tenants with rights of survivorship.

What about mortgaged property - do I use the net value or the gross value?

While it may be unfair if the estate is heavily leveraged, the commission is taken on the gross estate, not the net.  If the result is too onerous, a beneficiary may wish to seek judicial relief.

An illustration of how to calculate the executor commission
Let's presume the following facts:  Decedent owned a vacation house worth $500,000 and a mortgage of $100,000, a primary residence owned with his wife as tenancy by the entirety worth $1,000,000 and a mortgage of $300,000, a $400,000 IRA payable to his wife, $200,000 in stocks and bonds, a $200,000 life insurance policy payable to his children, and $100,000 worth of insurance with no beneficiary. 

Let's also presume that there is only one executor and during the administration, the $200,000 of stocks and bonds gave off $5000 of income. 

Included for purposes of calculating the commission are:  the $500,000 house, the $200,000 in stocks and bonds and the $100,000 life insurance policy with no beneficiary (for a total of $800,000).  There is no deduction for the the $100,000 mortgage.  The primary residence, the IRA and the $200,000 life insurance policy are excluded.

5% on the first $200,000 would be $10,000
3.5% on the next $600,000 would be $21,000
6% on the $5000 of income would be $300
So the executor would be entitled to a total commission of $31,300.


Final thoughts about executors commissions

Any commission that an executor takes will be subject to an income tax.  As a result, if the executor is also a beneficiary, he or she may not want to take a commission.  Additionally, many times relatives do not appreciate the amount of work involved and will become upset at an executor if he or she takes a commission. You should think about the dynamics of your family before taking one.

An executor that does extraordinary work can apply to the court for a commission in excess of the statutory fee.  An executor that behaves badly can be removed by the court.  If an executor or administrator is removed from office, he or she may be required by a judge to forfeit his commissions.  This is not automatic though.

Finally, as discussed in back in May of 2013, an attorney who is serving as an executor may be entitled to a fee for legal services AND a commission.

Thursday, February 13, 2014

Gifting to Parents to Save on Capital Gains Taxes

As I gaze outside at yet another major snowstorm here in Mercer County, NJ and contemplate how nice it would be if I were visiting my folks near my Boca Raton, Florida office, I am reminded of a tax savings idea that I heard was gaining traction amongst wealthy children whose parents are still living.

With the federal estate tax exemption up to $5,340,000 after its most recent adjustment for inflation, children that own highly appreciated assets (such as stock or real estate) can simply gift these assets to their parents now. When the parent passes away, the children can receive these assets back with a stepped up basis, potentially saving hundred of thousands of dollars in capital gains taxes when the assets are finally sold.

While at first blush this seems like an incredibly easy strategy to save money on taxes, there are actually many pitfalls. In particular, the strategy will not work well if:
1) the parent is receiving Medicaid or government benefits;
2) the parent lives in a state or jurisdiction that has a state estate tax or inheritance tax;
3) the parent has remarried; 
4) the parent has significant wealth and has their own estate tax problems; or
5) MOST IMPORTANTLY, the gift must be made to the parents at least one year prior to the parent's death to avoid triggering Section 1014(e) of the Internal Revenue Code.*

Additionally, there could be problems if you have siblings or step siblings as the child who originally owned the assets would obviously want to ensure their return. Here is the final catch, the IRS will not like it if you prearrange this plan. In other words, the parent can't immediately promise/guarantee that they will redirect the asset to the child.

Finally, gifts of certain assets will require an appraisal for the federal gift tax return that would be required (Form 709), potentially making this a costly transaction.

Please contact our attorneys if you would like to learn more about this type of gift planning or any other estate planning.

*Updated on 5/22/14 to reflect the need to make the gift at least one year prior to parent's death.

Friday, January 3, 2014

One Does Not Simply Inherit Assets in New York

I am in the midst of one my of my more difficult estate administrations in New York, and I thought it would be worthwhile to remind everyone how important it can be to set up a revocable trust in situations where you are leaving your estate to someone other than your next of kin.

In the matter I am working on now, the decedent (let's call her Jane) passed away leaving everything to her long time boyfriend and one other person.  Jane was not married and had no children, but she did have many siblings and nieces and nephews.  Even though Jane had a Will, the State of New York is requiring that we get each of Jane's surviving siblings to sign an affidavit approving of the probate of the Will. (This is known as a Waiver of Process; Consent to Probate Form.) 

Jane also had one sibling (Fred) who died before her.  So we have to get this form signed by all of Fred's children as well.  Should I bother mentioning that everyone has lost contact with one of Fred's sons?

Unless EVERY one of Jane's next of kin signs this form, the proposed executor has to go through extra steps to start his or her job.  This means the bills don't get paid, real estate can't get sold, and money can't be transferred to the people named in Jane's Will.

The need to have this form signed will wind up costing the estate a lot of time and money as the Executor must make diligent effort to track down this missing nephew.  It will also complicate matters if any of Jane's siblings or Fred's children does not sign and notarize the form required by New York.  Other than doing the right thing, none of Jane's relatives has any incentive to sign this form.  In fact, if any of Jane's relatives believe that Jane's boyfriend shouldn't inherit, they can certainly make it a difficult and expensive process.

If Jane had properly titled her assets in the name of a revocable trust and named beneficiaries on her IRA and life insurance policies, she could have helped her loved ones avoid the probate process.  By avoiding probate, all of these steps become unnecessary and would have saved everyone time, trouble and money.