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Tuesday, December 27, 2011

Updates for 2012

I've been remiss in not writing very much lately, but I do need to advise everyone that starting January 1, 2012, the federal estate tax exemption is actually going to increase from $5,000,000 to $5,120,000 due to adjustments for the cost of living. The federal estate tax rate remains constant at 35%.

Starting in 2013, unless the government acts:

  1. the current estate tax exemption amounts will revert to their 2001 level, adjusted for inflation (probably giving us an exemption amount near $1,300,000);

  2. the estate tax rate will return to a graduated rate, with taxes as high as 55%; and

  3. we will not have portability.

Have a happy holidays and great New Year.

Monday, October 31, 2011

Checking in with Your Relatives

I was talking to an elder care coach that I know by the name of Thomas P. Callahan, of A.F.I. Coaching and Consulting, and we started talking about our holiday plans. One interesting item that came up was how busy he tends to get right after the holidays. During this time of year, children return home to visit their elderly parents and become fully aware of how their parents have deteriorated over the course of the year.

If you are visiting home for the first time in a while, here are some warning signs that you should look out for if you are concerned about a loved one:
  1. If they are hoarding items (Such as numerous cereal boxes or sugar packets);
  2. If they have many unpaid bills;
  3. If they are becoming paranoid;
  4. If they having memory issues (do they repeat stories or fail to notice items right in front of them);
  5. If they have substantial weight loss or weight gain;
  6. If they are eating out a lot;
  7. If they are relying on untrustworthy companions (are they isolated from their normal friends and neighbors);
  8. If their car starts to have more dings and dents;
  9. If the laundry is not being cleaned;
  10. If they are sleeping on the couch or recliner instead of the bed; or
  11. If they are watching much more television than they used to.

According to Tom, these traits often go unnoticed because people view their parents as always capable…after all, they are your parents. They are the people you turned to as a child if you fell down.

It is important not to get frustrated when these things start to happen. That leads to unnecessary arguments. If you are seeing your parents exhibiting these traits, you must understand that your parents may not understand what is happening to them.

There are many creative ways to help, but letting things go on as they are is NOT a resolution. As a starting point, you will want to speak with an elder care coach. You will also want to make sure that you know where your parents Wills, Powers of Attorney and Advanced Health Care Directives are located. If they do not have any, you will want to encourage them to meet with an estate planning attorney before they are no longer have the ability to prepare such documents.

Tuesday, October 11, 2011

New Florida Power of Attorney Law

Effective October 1, 2011, a new law went into effect dramatically changing the Florida Power of Attorney Statute. A Power of Attorney is a writing in which one party grants authority to an agent to act in place of the principal; each act performed by the agent pursuant to the power of attorney has the same effect and benefit to the principal and the principal's successors in interest as if th principal had performed the act.

Important changes in the new Florida law include:
  1. An individual can no longer make a springing power of attorney - a springing POA is a power of attorney that becomes effective in the event of disability or some future contingent event (there is an exception of military powers);

  2. All Florida Powers of Attorney must be durable powers of attorney (i.e. they must be effective when signed);

  3. A Grantor must specifically initial any provision that allows for:
    - gifting, changing beneficiary of a retirement account,
    - changing any benefiary of an annuity,
    - changing the ownership or beneficiary of a life insurance policy,
    - amending, modifying, creating, revoking or terminating a trust,
    - waiving the principal's right to be a beneficiary of a joint and survivor annuity, including surivor benefits under a retirement plan, or
    - disclaiming property and powers of appointment;

  4. If multiple agents are named, absent explicit direction otherwise, each agent may act unilaterally. This changes the presumption, it used to be that if multiple agents were named, they had to act together; and

  5. Third parties are required to accept a copy of the power of attorney (and not demand an original).
The new Power of Attorney Act also modifies and clarifies the duties of an agent. Specifically, the agent may not delegate authority to act as agent (except for investment functions), the agent must keep record of all receipts, disbursments and transactions made on behalf of the principal, and the agent may not act contrary to the principal's reasonable expectactions, including preserving the principal's estate plan.

The changes are not retro-active, so powers of attorney drafted before October 1, 2011 are still valid (including gifting provisions that are not initialed). However, to avoid confusion, it may be best to redo any older power of attorney forms you have.

Saturday, October 1, 2011

Life Insurance for College Students

I was speaking with a colleague of mine the other day and the subject of college loans came up. It occurred to us that with the new stricter lending regime, it is probably more important than ever for a parent to consider getting life insurance on a child of theirs if they are co-signing a college loan.

Most college loans are no longer dischargeable in bankruptcy or upon the death of a child. So if you are co-signing a loan, consider taking out a life insurance policy on your child to pay off the loan in the event something happens to your child. As always, the larger the policy you obtain, the more worthwhile it is setting up a life insurance trust.

Friday, September 23, 2011

Deficit Reduction Package - Change in Estate Tax Exemption?

It's way too early to know if President Obama's Deficit Reduction Package will have any traction, but I did want to point out that under his proposal, the federal estate tax exemption would be reduced from the current level of $5,000,000 per person to $3,000,000 per person starting in January of 2013. Additionally, the maximum estate tax rate would go from the current rate of 35% to 45%. The changes in the estate tax exemption amounts and rates would be part of an overall package to reduce the deficit.

I am skeptical this will pass mainly because ever since the Republicans have taken over the House, President Obama and the Democrats have not been able to successfully pursue much of their agenda. It is worth noting though that the Democrats do have significant leverage with respect to this one tax because in the event the parties cannot agree on anything, after 2012 the federal estate tax will revert to pre-2001 levels. This would mean a federal estate tax exemption amount of $1,000,000 (indexed for inflation) and a maximum estate tax rate of 55%.

Wednesday, September 7, 2011

Dangers of Specific Bequests and General Bequests

A specific bequest is a gift of a specific piece of property to a specific person. Three examples of this are:
  1. I give my real estate, located at 1 Main Street, Anytown, State, to my son, Jake Smith.

  2. I give my 500 shares of stock of XYZ Corporation to my nephew, Jordan Smith.

  3. I give all of my money in Bank Account number #1 at Big Bank, to my daughter, Samantha Smith.
A general bequest is a gift of a specific amount, made to a specific person. This is considered a general bequest because only the value of the property is relevant, not its source. An example of a general bequest is: I leave $10,000 to my niece, Jody Smith. (It is not important from where the $10,000 comes from.)

If the testator states the source of the funds, this is a general bequest known as a demonstrative gift. An example of this is: I give $10,000 to my cousin, Jamie Smith, from my account number #1 at Big Bank. The gift amount is general, but the source of the funds is specific.

If you just leave everything to a specific person or persons, this is known as a residuary gift. I will not be discussing them in detail here.

Some of the dangers that can arise from an improperly drafted specific bequest include ademption, confusion, an unequal sharing of taxes and an unequal sharing of expenses.

Ademption is the term used when the decedent no longer owns the property that he or she is giving away. For example, if the decedent in the example above sold 1 Main Street shortly before his death and purchased 2 Main Street, then Jake Smith will get nothing. Because the decedent does not own 1 Main Street at the time of his death, he cannot possibly give it to Jake and the property is considered to be adeemed.

Another huge problem with ademption occurs when an agent under a power of attorney sells the property. Then, it will depend upon the state whether the beneficiary gets something or not as some states require that the beneficiary receive an amount equal to the fair market value of the property. I prefer not to specifically name anyone as the beneficiary of real estate or other large ticket items, and if the client insists, I require that they tell me what they would want to do if the property is sold before they die.

Confusion can result in a number of different ways. One way it can result is if one of the people named as beneficiaries dies - what happens to the bequest? It may depend upon the state. Some states say that the gift goes to the children of the deceased beneficiary. Some states say that the gift lapses. I prefer to explain what happens in all cases and not rely on state law. I will add one of the following in every case: "If Jody Smith does not survive me, this gift shall lapse." or ""If Jody Smith does not survive me, this gift shall be distributed to..."

Another cause of confusion can arise from gifts of stock. What happens if the stock splits or the company creates a subsidiary or is bought out? The answer to this can vary by state. Unless the testator is the owner of a small business and we are engaged in business succession planning, I usually advise clients not to make specific gifts of stock.

Making a specific or a general gift can result in an unequal tax burden because in many states, like New Jersey and Pennsylvania, there is an inheritance tax. Beneficiaries will be taxed differently depending upon their relationship to the decedent. So, if a New Jersey decedent left $10,000 to his son and $10,000 to his nephew, the nephew's gift would result in a 15% tax, but there would not be any tax on the bequest to his son.

If a Pennsylvania decedent left $10,000 to his daughter and $10,000 to his brother, the bequest to his daughter would result in a 4.5% tax and the bequest to his brother would result in an 12% inheritance tax. For a full range of all the different tax rates, please review this inheritance tax chart.

So, who should pay the tax in these situations? You can have three results:
  1. Each person who receives money pays their own taxes at their own rate.

  2. They split the taxes equally.

  3. The residuary beneficiaries (possible a third party) can be required to pay the taxes.
Each state has a different requirement, but the testator can override state law by stating who should pay the taxes. A good attorney will help you identify when this might be an issue and help you decide how the taxes should be paid.

A similar analysis can be made for the unequal sharing of expenses. If you leave $90,000 to your daughter in a specific bequest and leave everything else to your son, most Wills require that the expenses of the estate administration be paid out of the residuary. This may be fine if your son is getting more than your daughter, but what if it's the same or less? These kind of issues must be dealt with in the estate planning stage, not after a person's death.

Estate Administration can be a bit complex, so make sure you contact an an experienced probate attorney if you even have the slightest doubt about how to handle any of these issues.

Thursday, September 1, 2011

Estate Administration and Bad Credit

Everybody knows that good credit is important for receiving favorable financing terms when buying a car or a house. Let me give you another reason to keep your credit up: the ability to act as administrator of the estate of parent or loved one.

When a person passes away without a Will, the closest next of kin can petition the Court to act as Administrator for the decedent's estate. The Court will usually agree to let the next of kin act as Administrator provided that they agree to pay for a Probate Bond. A Probate Bond is basically an insurance policy that insures provides the intestate beneficiaries and creditors of the estate with a way to receive some money in the event the Adminstrator absconds with the funds.

The Court will require a probate bond in almost all situations in which the decedent dies without a Will. A person can only qualify for a Probate Bond if he or she has good credit or significant assets to their name.

Obviously, the way to avoid this situation is to make sure your parents and loved ones prepare a Will which states that no bond is required. However, you find that you are involved in an estate administration in which the decedent did not prepare a Will, before you spend a lot of money trying to qualify as an Administrator, Executor or Trustee, make sure you have good credit.

Friday, July 29, 2011

Step-Up in Basis Rule - Common Mistakes

When a person sells property, that person has to pay a tax on the gain from the sale. Gain is determined by subtracting the sales price of the object from the basis of such object. For example, if I sold a stock for $100 and the basis was $40, the gain would be $60.

The basis of an object is generally the price a person has paid for it. However, if you pay money to improve the object (such as buying an addition onto a house), the basis will increase. If you depreciate an object for tax purposes, the basis will decrease. To more on the basics of basis, see my post:
Understanding Basis.

Notwithstanding the crazy rules for an individual who may have passed in 2010, Section 1014 of the Internal Revenue Code states that if a person holds property at the time of his or her death, it will receive a new basis equal to the fair market value of such property at the person's date of death. This is known as the Step-up In Basis Rule because in almost all circumstances, the fair market value of the assets owned by a decedent is greater than the basis of in the decedent's hands just before he or she died.

However, the Step-up In Basis Rule is really more accurately called the Fair-Market Value Date of Death because, especially in this economy, there is a chance that the date of death value is less than the basis just before death. So the first mistake many people make is in not selling assets before they pass on which they can take a loss. If you bought stock for $20,000 and now it is only worth $10,000, consider selling it. If you sell it before you die, you can take the tax loss, if you keep it until you die, your heirs cannot claim that tax benefit.

If you are an executor or an elder law practitioner, you should also be aware that you have the option of valuing all assets under Section 2032 alternate valuation date. The alternate valuation date is six months following the date of death. So let's say on the date of death the assets are worth $5,500,000 and six months following the date of death they are worth $5,000,000. Unless there is a state estate tax, you may be better off using the alternate valuation date so that the beneficiaries have a higher basis in the property, even if there is a small federal estate tax. On the other hand, if, six months after the date of death, the assets are worth more, you are not permitted to use the 2032 elections.*  (See 2032(c).) The second common mistake made by many is to not wait the six months and run the calculations for both scenarios.

So, if the beneficiaries of a descendant's property get to take appreciated property with a step up in basis, why don't people just transfer their property to a sick relative and then have them bequeath it back them when the sick relative dies. Well, unfortunately, this rarely works. Often times, it can result in a gift tax, inheritance tax or estate tax. Additionally, under Section 1014(e), if you receive a property by gift, you have to hold it for one year before your heirs can get the benefit of the step-up in basis rule. This is the third common mistake. When doing an estate administration, many practitioners and accountants fail to adequately track the basis of the assets.

*Updated on 5/5/14.  Thanks to Bob Derber for pointing out that I also made a common mistake!

Monday, July 11, 2011

The Biggest Danger of a Roth IRA Conversion

After speaking with a client who did a ROTH IRA conversion last year, I realized that there is a major danger to these conversions. You cannot assume that the financial instituion will designate the same beneficiaries on the ROTH IRA as had been named under the traditional IRA. Many financial instituions will send out beneficiary designation forms separately, long after the converison has been done. If the owner is not expecting it, he or she may just throw away the form.

It is very important for anyone who has done a ROTH IRA conversion to double check the beneficiaries on the new account to ensure they are what you want. This is particularly true if you want to name an IRA Stretch Trust.

Thursday, June 23, 2011

The Future of Estate Tax: Will “13” Prove To Be A Lucky Number?

In my blog post of November 12, 2010, I made reference to a dinner bet I made with my father as to when a decision would be made on the federal estate tax issue. (Yes, Dad, I haven't forgotten you were right and I still owe you dinner.) At that point, we were nearing the end of a year in which there was no estate tax and we were about to revert to a tax, up to 60%, on transfers at death in excess of $1,000.000.

In an 11th hour move on December 17, 2010 President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act into law, which reinstated the federal estate tax – but with a $5 million exemption limit and a 35% tax rate - to begin again January 1, 2011 and to sunset on December 31, 2012. Additionally, the concept of portability of the estate tax exemption between spouses was introduced.

So while we achieved relative certainty for two years, January 1, 2013 now marks the unlucky date of reversion to the $1 million estate tax exemption, estate tax rates as high as 60%, and an elimination of the portability provision.

To provide longer term certainty, President Obama, in his recently proposed 2012 budget, is hoping to change the estate tax exemption to $3.5 million, the same as it was in 2009. Additionally, he is seeking to reduce the gift tax exemption and GST tax exemption to $1,000,000 with an increase in the estate and gift tax rates to 45%. The proposal includes making portability of the exemption amount between spouses permanent, for a combined exemption up to $7 million.

You can look at President Obama's approach in two ways. You consider this change as increasing the estate tax (by raising the tax rate and lowering the exemption from its current level). However, you can also consider this reducing the estate tax (by lowering the tax rate and raising the exemption from what would happen in 2013 if nothing were done.) All I hope for is an end to these constant changes. It will be lucky for everyone when we have certainty, beyond two years, on the issue of the estate tax.

I should note that uncertainty is likely to remain as I doubt Congress will agree with President Obama's plan. Republicans control the House and they are still looking for a full repeal of what they call “the Death Taxes.”
Thank you to my paralegal, Elizabeth Carter, for help with this post.

Friday, May 27, 2011

Federal Estate and Gift Taxation of Deathbed Gifts

Often times, a person who is on his or her deathbed will wish to make gifts to family members. A gift is usually considered a deathbed gift if it is made within three years of a person's death. However, except for certain transfers discussed below, when a gift is made is often irrelevent for federal estate tax purposes because there is a lifetime lookback, not just a three year lookback.

Making gifts in a way that minimizes taxes is actually a very complex process. In deciding whether to make a gift, one must consider the amount of the gift, the type of asset you wish to transfer, to whom it is going to and the basis in the gifted item. I will not be discussing advanced topics such as discounted gifts or generation skipping tax transfers in this post.

The Tax Effect of a Gift

To understand the effect of a gift for federal estate and gift tax purposes, we need to start with a short discussion of the current law.

United States citizens and permanent resident aliens currently can give away an unlimited amount to a US citizen spouse or a charity without incurring a gift tax or an estate tax. US citizens and permanent resident aliens can give away up to $5,000,000 to anyone else. This is known as our lifetime exemption amount, unified credit amount or applicable exclusion amount. (Note, transfers to a spouse who is a permanent resident alien are not unlimited, they are capped by the lifetime exemption amount.)

After 2012, this $5,000,000 amount will be reduced down to $1,000,000 unless the legislation is modified. (I think it is highly unlikely that it will go back down to $1,000,000, but $3,500,000 is quite plausible.) Gifts of less than the $5,000,000 lifetime exemption amount will not result in a tax; they merely reduce the donor's exemption amount and the amount the donor can transfer on death.

In addition to the lifetime exemption amount, each person can make annual exclusion gifts without any tax liability. Annual exclusion gifts are also known as 2503(b) gifts. Gifts in excess of the annual exclusion amount (currently $13,000 per donee per year) are taxable for federal gift tax purposes. When I say that gifts in excess of the annual exclusion amout are "taxable", that means the gift reduces the donor's lifetime exemption, or, if the lifetime exemption has been used up, these transfers will result in a taxable gift. Currently, the gift tax rate and estate tax rate are 35%.

To complicate matters, if the donor is married, he or she can "split" the gift with his or her spouse. For example, let's say I gift $7,000,000 to my two children. If I make the gift alone, $26,000 of the gift is sheltered by my annual exclusion amount ($13,000 for each child). The balance, $6,974,000, reduces my lifetime exemption from $5,000,000 to $0 and results in a taxable gift of $1,974,000. At 35%, the tax on this gift would be $690,900. However, if I had split that gift with my wife, we could also use her annual exclusion amount making the taxable gift to the kids only $6,948,000. Additionally, the taxable gift would be split in half, reducing each of our lifetime exemptions to $1,526,000 and no gift tax would be due.

Gift splitting is available to married couples if each spouse is either a citizen or a resident of the United States. (
I.R.C. 2513) In other words, you may gift-split with a non-citizen spouse provided he or she is resident alien.

The power of gifting using the annual exclusion exemption cannot be emphasized enough. If you have an elderly widow who has $8,000,000 who gifts $13,000 to each of her children (4),each of her grandchildren (10) and each of the spouses of her children and grandchildren, that widow can give away 28 gifts of $13,000 tax free. That's $364,000. If she does that for 9 years until she dies, she can pass on 100% of her estate to her heirs without any federal estate tax. If she had kept the $8,000,000 until her death, there would have been a $1,050,000 federal estate tax.

To get a better idea of the power of lifetime gifting using the annual exclusion amount, read my blog post on
deathbed transfers in New Jersey in which I discuss gifts by Tabitha and Genie.

For all gifts discussed to this point, it would not have mattered when the gift was made. Gifts equal to or less than the annual exclusion amount do not count against the $5,000,000 exemption amount while those in excess of the annual exclusion amount do regardless of when they were made. It is now time to learn about about some special rules.

Gifts of Certain Assets are Subject to a Three Year Lookback Rule

Many people assume, incorrectly, that proceeds from life insurance policies are paid to the beneficiaries free of tax. While this is true that there is no income tax on such proceeds, it is not true for the estate tax. If a decedent OWNS a life insurance policy insuring his or her own life, the entire death benefit is includible the decedent's estate, regardless of who the beneficiary is. If the value of this death benefit plus the decedent's other assets result in the decedent having an estate over the $5,000,000 limit, the overage will result in a federal estate tax unless the estate is entitled to a marital deduction or charitable deduction.

Under Section 2035 of the Internal Revenue Code, certain assets that are transfered by a person who dies within three years are considered to be owned by the person at his or her death. This rule most significantly applies to the transfer of life insurance policies. So, if a decedent transfered OWNERSHIP of a policy on his life to another party within three years of death, the 2035 rule kicks in and it is considered a taxable deathbed gift equal to the full face value of the policy - not just the value of the policy on the date of the gift.

You should also be aware that the Section 2035 lookback rule also applies to the release of certain interests in trusts and real estate. Additionally, if the decedent paid any gift taxes within three years of death, that will be added back into the donor's gross estate, and the donor will get a credit for the taxes paid. Since these items do not affect most people, I will not discuss them in depth.

Gifts in Which the Donor Retains an Interest or Control

There are many ways to make a gift. I can give you a house or I can draft a deed, keeping a life estate for myself and then giving you the house when I die. I can give you 30% of my company or I can give you 30% of my company and retain the right to vote your stock.

The general rule is that if I make a complete gift, retaining no interest or control, it is a completed gift and will not be includible in my gross estate. If I retain any control or interest, such as a life estate or a right to vote your stock, then the gift, even though complete, will still be includible in my gross estate.

I can also fashion a gift in a manner in which there is a chance that I receive the property back. For example, I can give you a property for your life and then to your father if he survives you, but if he doesn't survive you, I get the property back. If you are much younger than me, there is a small chance that I will get the property back. If you are much older, than the chance I will get the property back is much greater. The probability that I will receive the property back is calculated as of the moment before my death, so the fact that I died before you is irrelevent. If the chance that I would have gotten the property back is greater than 5%, then the value of the property at the time of my death is includible in my gross estate.

What's the big deal if the property is includible in my gross estate if there's a lifetime lookback? Well, let's back to the example in which I transferred a 30% stock interest. Assume that at the time of the gift the 30% interest of the stock was $1,000,000 and at the time of my death that same interest was worth $7,000,000. If I had not kept an interest in the stock, it would have just reduced my lifetime exemption by $1,000,000. By keeping the voting interest, the full $7,000,000 value will be included in my estate resulting in a federal estate tax of $700,000 (35% of $2,000,000).

The Importance of Knowing the Basis of the Gifted Item

As discussed on my post on deathbed transfers in New Jersey it is wise to know the basis of the property that is being gifted. If the donor is gifting an asset, the recipient receives the gift with the same basis as it had in the hands of the donor. This is known as a carry-over basis.

Accordingly, if the donor gifts an asset that it is highly appreciated, it will result in a substantial capital gains tax when the donee ultimately sells it. If, on the other hand, the donor gave the item to donee on his death, the asset would take on a basis equal to the fair-market value of the property as of the date of the donor's death.

Due to the carryover basis rule, it is usually best not to give away appreciated property during life. It is better to either gift away cash or hold on the the asset until death and have the beneficiaries pay a smaller estate tax.

The Benefit of Making Taxable Gifts

Reading through this post, the benefit of making gifts equal to or less than the annual exclusion amount is quite evident, but you may be asking yourself why anyone would wish to make a taxable gift that uses up a person's exemption amount. Look back to the situation where the donor gave away a 30% interest in stock worth $1,000,000 and that stock grew to $7,000,000. It is much better, for tax purposes, if that grows in the hands of someone other than the person who is likely to die first. This technique is known as an "estate freeze" because reduces the chance of assets growing in the donor's hands.

Filing requirements for Taxable Gifts

You should also be aware that if you do make a gift in excess of the annual exclusion amount, you should file a federal gift tax return (Form 709).

Thursday, May 26, 2011

Deathbed Transfers in New Jersey

Often times, a person who is on his or her deathbed will make gifts to family members in an effort to reduce the potential taxes owed.

For transfers to anyone other than a charity, making gifts in a way that minimizes taxes is actually a very complex process. In deciding whether to make a gift, you must consider the amount of the gift, the type of asset you wish to transfer, to whom it is going to and the basis in the gifted item.

Taxes That Must be Considered When Making Gifts

There are generally six taxes that might be triggered as result of the gift. These include the New Jersey estate tax, the New Jersey inheritance tax, the federal estate tax, the federal gift tax, the capital gains tax and the generation skipping transfer (GST) tax.

I discuss all of these taxes in more detail elsewhere, but to quickly review the general purpose of each tax:
  1. The New Jersey estate tax is imposed by the state on transfers at death to the extent the decedent's net estate exceeds $675,000 and the money passes to someone other than a charity, surviving spouse, domestic partner or civil union partner.

  2. The New Jersey inheritance tax is also a tax imposed on transfers at death. However, the inheritance tax is based more upon who the money is going to rather than the amount involved. New Jersey does offer a dollar for dollar credit against its estate tax for any inheritance tax paid.

  3. The federal estate tax is imposed by the federal government on transfers at death to the extent the decedent's estate exceeds $5,000,000 and the money passes to someone other than a charity or a surviving spouse.

  4. The federal gift tax is imposed by the federal government on transfers during a person's lifetime to the extent the person's lifetime gifts exceed $5,000,000 and the money is transferred to someone other than a charity or a spouse.

  5. The generation skipping transfer tax (also known as the GST Tax) is generally assessed by the federal government on transfers during life or at death to a person's grandchildren, or more remote descendants to the extent such transfers exceed $5,000,000.

  6. The capital gains tax imposed on the sale of appreciated property, stock or similar assets.
As you may have noticed, only four of the six taxes named above are directly attributable to a transfer being made as the result of someone dying. The reason that a lifetime gift can be taxed at the donor's death is because New Jersey and the federal government have lookback provisions. Lookback provisions basically say that if you make a certain kind of transfer, the government can tax it at your death even if you gave the money away during your life. As you can imagine, this creates a host of problems including finding a way to pay for the tax.

What is a Deathbed Gift?

New Jersey defines deathbed gifts as gifts made in contemplation of death (N.J.S.A. 54:34-1(c)). People usually know the deathbed gift rule as the three year lookback rule because gifts made within three years of death are presumed to be in contemplation of death. If a gift is made in contemplation of death, and the gift was over $500, then New Jersey asserts it was really a transfer at death subject to the inheritance tax.

For New Jersey tax purposes, this particular three year rule ONLY appears under the NJ inheritance tax statutes. There is a very different rule for the New Jersey estate tax because the New Jersey estate tax generally follows the federal estate tax for determining what is taxable and what is not taxable. I will discuss this in more detail below.

Since gifts made in contemplation of death are subject to an inheritance tax, and the inheritance tax only applies for transfers to certain beneficiaries, it is important to know how New Jersey classifies the beneficiaries of the gift.

Determining the Class of the Beneficiary

To determine if a lifetime gift will result in a New Jersey inheritance tax, the first thing that you must do is differentiate between gifts made to Class A beneficiaries, Class C beneficiaries and Class D beneficiaries.

Class A beneficiaries include the decedent's spouse, civil union partner, domestic partner, all lineal descendants (such as children, grandchildren and great-grandchildren), all lineal ascendants (such as parents, grandparents and great-grandparents) and step-children. An adopted child, grandchild or great-grandchild is also considered a lineal descendant. Transfers to Class A beneficiaries are exempt from the NJ inheritance tax, meaning there is no inheritance tax on deathbed gifts or transfers at death to such individuals.
Class C beneficiaries include the decedent's brother or sister and son-in-law or daughter-in-law of the decedent even if the decedent's child is also deceased. Class D beneficiaries includes everyone else (most notably nieces and nephews).

If the gift is made to a Class C Beneficiary, and the gift was over $25,000, there definitely will be a NJ inheritance tax if the gift was made "in contemplation of death". If the gift was made more than 3 years prior to the decedent passing, it will not be subject to a NJ inheritance tax.

If the gift is made to a Class D Beneficiary, and the gift was over $500, there definitely will be a NJ inheritance tax if the gift was made in contemplation of death. If the gift was made more than 3 years prior to the decedent passing, it will not be subject to a NJ inheritance tax.

If the deathbed gift is subject to the New Jersey inheritance tax, there will be a tax due of 11-16% of the transferred amount. There is an 11-16% tax on transfers to Class C beneficiaries on the gifted amount in excess of $25,000 and a 15-16% tax on the entire transfer to Class D beneficiaries if the gift is in excess of $500. The more that is transferred, the higher the rate will be.

As an example, assume I owned $5,000,000, and I gifted away $1,000,000 to my nieces and nephews four years ago, $3,500,000 to my nieces and nephews this year and then died within three years, leaving the remaining $500,000 to my two siblings. The $1,000,000 gift to my nieces and nephews would not be subject to a New Jersey inheritance tax because it was longer than three years ago. The first $700,000 of the $3,500,000 deathbed gift to my nieces and nephews would be taxed at a 15% inheritance tax rate ($105,000). The remaining $2,800,000 would be taxed at a 16% inheritance tax rate ($448,000). For the transfers to my siblings, $50,000 will pass free of taxes, and the remaining $450,000 will be taxed at an 11% inheritance tax rate ($49,500). In total, there will be a $602,500 NJ inheritance tax.

For gifts to charity in any amount and gifts of less than $500 to any person, there is an easy answer - it is not subject to an inheritance tax in New Jersey.
Regardless of what classification a beneficiary is in, there MAY BE a New Jersey estate tax and/or federal estate tax if the gift is subject to a three year lookback under the federal estate tax rules or a lifetime lookback if the gifted items are in excess of the annual exclusion amount.

Certain Transfers are Automatically Subject to a Three Year Lookback for Estate Tax Purposes

Under Section 2035 of the Internal Revenue Code there is a limited three year lookback that most significantly applies to life insurance policies transferred within three years of death.
A. Life Insurance: If you learn nothing else from this post, make sure you learn this:
  1. If a decedent OWNS a life insurance policy insuring his or her own life, the entire death benefit is subject to both the New Jersey estate tax AND the federal estate tax. Many people assume life insurance proceeds are tax free. While this is true for income tax, it is not true for estate tax. The only relief is if the beneficiary is a charity, a surviving spouse, a civil union partner or domestic partner because then the estate may be entitled to a deduction;

  2. If the decedent transferred OWNERSHIP of the policy on his life to another party within three years of death, the 2035 rule kicks in and it is considered a taxable deathbed gift.
B. You should also be aware that the Section 2035 lookback rule also applies to certain interests in trusts and real estate. This does not affect most people, so I will not discuss them here.

Gifts in Excess of the Annual Exclusion Amount

Currently, each United States citizen and permanent resident alien can give away $13,000 to as many donees as he or she wishes. This is known as the federal annual exclusion amount or 2503(b) exclusion. Gifts in excess of the federal annual exclusion amount result in a "taxable gift". Usually there is no immediate out of pocket expense though because New Jersey does not have a gift tax and the federal government will only institute a gift tax if the sum of these gifts exceeds the lifetime exclusion amount (currently $5,000,000).

When calculating the New Jersey estate tax, we are required to look not just at what a person owned when he or she died, but also the taxable gifts that the decedent made over his or her lifetime.

In most situations, if the decedent's taxable estate, including prior taxable gifts, is in excess of the New Jersey estate tax exemption amount (currently $675,000), there will be a New Jersey estate tax. However, there is a big difference in the tax depending upon whether the decedent died with estate over the $675,000 threshhold or died with an estate under the $675,000 threshhold, but is deemed to have an estate in excess of $675,000 due to the lookback provisions.

As an example, assume I owned $5,000,000, and I gifted away $4,500,000 to my daughters and then died in 2012 as a widower, leaving the remaining $500,000 in my estate to my children. Normally, there would be no estate tax on a New Jersey estate of only $500,000, but we must add back the prior gifts. Even adding back the prior taxable gifts, it would only produce a $10,000 NJ estate tax. (To learn how this is calculated, you will need to prepare a 2001 Form 706 federal estate tax return and a New Jersey estate tax return. I will discuss this in future post, entitled "Deathbed Transfers in New Jersey - Advanced")

To realize the benefit of making this gift, you should know that if I had died with the entire $5,000,000, my estate would have to pay a $391,600 New Jersey estate tax. In years past, nobody would give away more than a $1,000,000 because that was the old lifetime gift limit for federal gift tax purposes. Any gifts above $1,000,000 were taxed at a very high gift tax rate. However, with a $5,000,000 lifetime federal gifting limit and no New Jersey gift tax, there is ample opportunity for planning to avoid or drastically reduce the New Jersey estate tax.

You should also be aware that if you do make a gift in excess of the annual exclusion amount, you should file a federal gift tax return (Form 706). If a lifetime transfer is in excess of the federal annual exclusion amount, it could lead to a federal estate tax or a federal gift tax at some future time. To minimize this possibility, you should try to structure gifts over longer periods of time and for an amount equal to or less than the annual exclusion amount. To read more about this, see my article entitled: Federal Estate and Gift Taxation of Deathbed Gifts.

The Importance of Knowing the Basis of the Gifted Item

It is important to know the basis of the property that is being gifted. If the donor is gifting cash, the basis is exactly the amount of the gift. If the donor is gifting property or stock, it may be unwise to make the deathbed gift because there could be substantial built-in capital gains.

When property is gifted away, the donee usually takes the property with a basis equal to that of the donor's basis. (For more on basis, see my post on Understanding Basis.) If the donor keeps property until his or her death, the recepient will receive the property with a new basis equal to the fair market value of that property on the date of the death. This is often referred to as a step-up in basis rule, although in this economy it may be a step-down in basis.

Let's assume I give away a real estate property worth $4,500,000 to my daughters shortly before I die to save on the New Jersey estate tax. If my basis in the property was only $1,000,000, the kids will take the property with that same basis. If my kids sell it immediately after I die for $4,500,000, there will be a 15% capital gains tax on the $3,500,000 of built in gain. This will produce a federal capital gains tax of $525,000 and probably a New Jersey income tax of $315,000. As discussed above, the New Jersey estate tax would have only been $391,600 if I had held onto the property.

Due to the carryover basis rule, it is usually best not to give away appreciated property during life. It is usually better to pay a smaller estate or inheritance tax than to risk losing the step-up in basis on the decedent's death.


In summary, large deathbed gifts are not necessarily going to be taxed after the donor passes. Whether there will be a New Jersey tax on a deathbed gift is based upon whether the transaction has occurred in the last three years, to whom the item is being gifted, the type of asset being gifted and on the size of the donor's net estate after factoring in prior gifts.

When all is said and done, even if there is a New Jersey tax (estate or inheritance), large gifts made to Class A beneficiaries prior to death and large gifts made to Class C and D beneficiaries more than three years prior to death will greatly reduce the overall estate and inheritance tax liability unless the donor is making a gift of a highly appreciated asset.

Simple, right?

I want to give a special thank you to Martin Bearg, Esq., Rekha Rao, Esq., Rebecca Esmi, Esq., and to individuals at the New Jersey Transfer Inheritance Tax Branch (who wish to remain anonymous) for taking the time to speak with me about this and helping me to gather my thoughts.

Monday, April 25, 2011

Verifying an Employee's Social Security Number

I just learned that the Social Security Administration has an online system to check that your your employee's name matches their social security number.

As many of you know, employers can get hit with huge penalties for hiring illegal workers. Some illegal workers try to obtain work by using another person's social security number. This system is a way to verify the person you are hiring is in fact legally allowed to work. It is known as the Social Security Number Verification Service (SSNVS).

Any employer can following the directions on the website to sign up.

Sunday, April 10, 2011

Understanding What "Per Stirpes" Means

Sometimes it's easier not to reinvent the wheel. Back in 2006, Debra M. Simon, CPA wrote an excellent article about Understanding the Pitfalls of Beneficiary Designation Forms. Included in that article is a clear explanation what it means to name your issue, "per stirpes" compared to naming your issue, "per stirpes by representation" as beneficiaries under a retirement account, Will or life insurance policy.
I strongly recommend anyone who has more than one child read this article because if one of your children passes before you, you may inadvertently be cutting your grandchildren out of your estate plan.
Thank you to Robert Kenny, Esq. for bringing this article to my attention.

Friday, April 1, 2011

Japanese Inheritance Tax vs. US Estate Tax (2011 Update)

(2011 Update)
NOTE: This information has been updated. The new post can be found at: http://willstrustsestates.blogspot.com/2014/08/japanese-inheritance-tax-vs-us-estate.html

I. Estate Taxes
A. America
1. Citizens and Permanent Residents
a. Tax on Worldwide property (credit for taxes paid to foreign countries)
b. Exemption of $5,000,000 in 2011 and 2012 (theoretically back to $1,000,000 in 2013 if no change to Federal Estate Tax). For married couples, the exemption amount is $10,000,000 as a result of portability.
c. Tax of 35% on amount over $5,000,000
d. Unlimited Marital Deduction for Surviving Spouse if Surviving Spouse is a citizen
2. Non-Citizens/Non-Permanent Residents
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 $13,000
c. Tax of between 18%-35% on amount over $13,000
d. Unlimited Marital deduction if Surviving Spouse a citizen
B. Japan (Actually an Inheritance tax, not an estate tax)
1. Japanese Citizens and Permanent Residents
a. Exemption of ¥50,000,000 + (¥10,000,000 for each statutory heir); Possible additional exemption for insurance money, retirement savings, and money left to handicapped individuals
b. Additional exemption for life insurance received of ¥5,000,000 multiplied by the number of statutory heirs
c. Tax between 10%-50% for statutory heirs; Tax between 30% to 70% for everyone other else (except charities);
d. For property outside of Japan, a beneficiary that acquires property will be subject to Japanese inheritance tax if the beneficiary is a Japanese national and the beneficiary was domiciled in Japan at any time during the five years preceding the receipt of the inheritance.
e. 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. If there is a tax, it appears a surviving spouse is entitled to the same marital tax deduction as for Japanese citizens.

II. Gift Taxes
A. America
1. Citizens and Permanent Residents
a. Tax on all gift transfers of Worldwide property
b. Annual exemption of $13,000 per person/per donee (unlimited gifts for donees if different donors)
c. An annual gift to a non-citizen, permanent resident spouse, of $136,000 is available.
d. Lifetime exemption of $5,000,000 (for years 2011 and 2012)
e. Gifts may be split with spouse
f. Tax rate of 35% if lifetime gifts exceed $5,000,000
2. Non-Citizens/Non-Permanent Residents
a. Tax on all gift transfers of US Property (including Cash and Stocks in US companies)
b. Annual exemption of $13,000 per person/per donee (unlimited gifts for donees if different donors)
c. No Lifetime exemption
d. Gifts may be split with spouse
e. Tax rate of 18%-35% if lifetime gifts exceed $13,000
B. Japan (Rates between 10%-50%)
1. Citizens and Permanent Residents of Japan
a. Annual exemption of ¥1,100,000 for each beneficiary (beneficiary taxed after this)
b. One time spouse exemption of ¥20,000,000
c. For property outside of Japan, a donee that acquires property will be subject to Japanese gift tax if the donee is a Japanese national and the donee was domiciled in Japan at any time during the five years preceding the receipt of the gift.
2. Non-Citizens/Non-Permanent Residents
a. Annual exemption of ¥1,100,000 for each beneficiary(unclear – enforcement is almost impossible)

III. Generation Skipping Taxes (Taxes on gifts or bequests to grandchildren)
A. America
1. Exemption of $5,000,000 in 2011 and 2012 (theoretically a return to a $1,000,000 exemption in 2013, but indexed for inflation)
2. Tax of 35% on rest
B. Japan
1. None

For more information on Japanese taxes, the Japanese government has a nice website in English with some helpful facts. This is a link directly to the inheritance tax information:

It is worthwhile reading the Japanese publication if you have business interests in Japan or if one of other special circumstances (like a handicapped heir) as there are many credits available.

Friday, January 28, 2011

The Mystery of Calculating Executor's Fees in Pennsylvania

The issue of calculating fees for an executor, executrix, administrator or personal representative in Pennsylvania estate cases is interesting because there is in fact no hard and fast rule about how such fees are to be calculated. Therefore no sure way to know what you can expect to see in the accounting if you are a beneficiary.

While executors’ fees are set by statute in many states, the “PEF” Code (the Pennsylvania Probate, Estates and Fiduciaries Code) provides only that a personal representative’s compensation shall be “reasonable and just” – based upon the specifics of each estate - and that it “may” be calculated on a graduated percentage. (20 Pa.C.S. §3537) The executor then has several options available, including charging (i) a flat fee or (ii) an hourly fee.

Though a "reasonable and just" standard may appear to be a very loose, wishy-washy standard, anyone acting as an executor or administrator should be aware that the executor’s commission will ultimately be subject to review on many levels: first and foremost, by the Orphan’s Court, to determine the reasonableness of the fee based upon the size of the estate, particularly if a beneficiary has objected to the accounting; second, by the Attorney General’s office, to review the fees’ effect upon the pay out of a charitable gift if a charity is a beneficiary of the estate; and third, by the Department of Revenue, to ensure against fraudulent deductions for fees claimed on the Inheritance Tax Return.

To guard against the prospect of an unfavorable audit, the Pennsylvania personal representative should take careful note of the percentage guidelines established by the court in Johnson Estate, 4 Fid.Rep.2d 6,8 (1983). In actuality, although the schedule established in Johnson was only included as an attachment to the judge’s written opinion, it has served as the unofficial guideline for gauging executor commissions and attorney fees ever since, with countless other judges adopting it as their own benchmark for review of accountings in subsequent cases.

Typically, if the ultimate commission is not more than what is provided on the Johnson schedule (below), and is calculated based upon standards of financial reason and fairness, it is likely that it will likely be met with approval all around.


Per Col.
Per Total


Executor or



Joint Accounts
P.O.D. Bonds
Trust Funds
Real Estate Converted
with Aid of Broker
Real Estate:
Real Estate:
Specific Devise
Reasonableness, however, always reigns: While the percentage method appeals to judges of the Orphans' Court, keep in mind the Pennsylvania Superior Court has criticized the practice in their own opinions in Sonovick Estate, 373 Pa. Super 396 (1988), and Preston Estate, 560 A.2d 160 (1989).

An Executor should also consider that money received as compensation for any fiduciary duties is taxable for federal income tax purposes and usually for state income tax purposes as well. Accordingly, the executor may want to elect NOT take a commission after all as he or she may receive more by just receiving his or her distributive share of the estate.

For purposes of this article, I have used the titles "executor", "executrix", "administrator" or "personal representative" interchangeably. All refer to the person or entity that is in charge of administering a decedent's estate. In fact, an executor or executrix is a party that is appointed by a Will; an administrator is a party that is not appointed by Will, but is approved by the Court; and a personal representative can be either a party named in a Will or appointed by the Court.

NOTE: Special thanks to Elizabeth Carter for helping to prepare this article.

Monday, January 17, 2011

Estate Planning for Non-Traditional Couples

For purposes of this article, I am going to define a traditional couple as a relationship between a man and a woman who are in their first marriage and the only children are children of the marriage. Estate planning for traditional couples usually consists of having a Will, Financial Power of Attorney, Medical Power of Attorney and Advanced Health Care Directive.

The traditional plan itself usually consists of each spouse leaving money to the other (occasionally in trust for tax planning purposes). On the death of the surviving spouse, everything is left to the children. The surviving spouse is usually executor and trustee of any trusts. If a traditional couple does not create a Will, the state's intestacy scheme will send the money in the same direction - but without any trust or tax planning.

There are typically three types of couples that need planning significantly different from that of traditional couples:
  1. Same Sex Couples
  2. Couples where at least one party has children from a previous relationship (often called "Blended Families"); and
  3. Couples who are in a long term hetero-sexual relationship but are not legally married.
For all non-traditional couples it is even more important to prepare Wills, Financial Powers of Attorney, Medical Powers of Attorney and Advanced Health Care Directives. However, while the documents stay the same, the methodology is very different.

The laws for same sex couples vary widely by state, and the federal government does not recognized the validity of a same sex marriages or civil unions for tax purposes or for most other purposes. If one partner dies without a Will, in most states, the state intestacy law will not direct that the money goes to the surviving partner. Additionally, in many states, the partner will have no rights to administer their loved one's estate or act as a guardian absent written instruction.

Since state law will usually not protect the rights of same sex couples, it is imperative for gay and lesbian couples to prepare a Will, Power of Attorney and Health Care Directive. Additionally, trust and tax planning becomes even more important as does coordination of the couple's other assets. This is particularly true if there are children involved.

Even in states where the law is favorable, same sex couples must plan to minimize the federal estate tax, as the unlimited marital deduction only applies to heterosexual couples. Planning must also be done to minimize state estate taxes and state inheritance taxes if the couple is thinking about moving to another jurisdiction.

For Blended Families, many of the traditional planning techniques do not work because the goal is not always to provide for the spouse first and then for the children. Special planning is needed to ensure that both the needs of the surviving spouse and children from the prior relationship are addressed. This often involves setting up irrevocable life insurance trusts or segregating assets.

For couples who are in a long term relationship but are not legally married, planning is often a sore point. Legally, such couples are pretty much in the same boat as same sex couples unless they living a jurisdiction that has common law marriage. If no planning is done, the surviving partner gets completely cut out.

Ignoring the issue not only leads to litigation, but a more expensive estate administration process and higher taxes. If you are in a non-traditional relationship, I strongly recommend seeing a competent estate planning attorney in a jurisdiction near you to flush out all the issues that affect you.

New York Statutory Power of Attorney

If you recall, I wrote an article back in 2009 that the New York legislature changed the requirements for the New York Power of Attorney form.

Looking around online today I noticed that most of the free New York Statutory Power of Attorney forms that are available online are WRONG. They are either old forms or do not include the Major Gifts Rider. This includes the New York State Bar Association form which appears on many government web sites.

Do not forget, if you want to make Major Gifts (defined by New York as gifts in excess of $500 per person per year under NY GOB LAW Section 5-1502I(14)), you must complete the separate Major Gifts Rider. Additionally, although the NY Power of Attorney form does not require any witnesses, the Major Gift Rider does. Both must be notarized - so be careful out there.

Wednesday, January 5, 2011

Inflation Updates for 2011

Every year the Internal Revenue Service publishes a list of inflation adjustments. Here are the important ones that relate to Gift and Estate Taxes and others that are just useful:
  1. 2011 Annual Gift Tax Exclusion will stay at $13,000. This means a person can give any other person at least $13,000 before it is subject to the federal gift tax. I won't go into the details about how and when it will qualify - just realize that as long as it is an outright gift, it will usually qualify. Also, a husband and wife may split a $26,000 gift for tax purposes before there is a gift tax.

  2. 2011 Annual Gift Tax Exclusion for Gifts to Non-Citizen Spouses will be $136,000. This is the maximum amount a person may transfer to a non-citizen spouse before the gift is subject to a gift tax. In order for US law to apply, we will usually be talking about a gift being made to a permanent resident alien spouse. One place where this gets triggered unexpectedly by many is retitling of real estate - so be give careful thought to this before changing ownership. This is up from $134,000 in 2010.

  3. The 2011 Federal Estate Tax Exemption will be $5,000,000. We've talked about this before, so it should not be a surprise to anyone that the estate tax exemption is settling at $5,000,000 for the next two years. This means that if you die in 2011, the federal government will not have a death tax on the first $5,000,000 that you pass on (unless you have made large gifts in previous years).

  4. The 2011 Federal Lifetime Gift Tax Exemption will also be $5,000,000 for the next two years. This is in addition to the annual gifts that a person can make. Beware of gifting highly appreciated assets!

  5. 2011 Reporting Requirements for Large Gifts Received from Foreign Persons: recipients of gifts from certain foreign persons may be required to report these gifts under § 6039F if the aggregate value of gifts received in a taxable year exceeds $14,375.

  6. 2011 Mileage Reimbursement Rates: the standard mileage rates for the use of a car (also vans, pickups or panel trucks) will be:
      • 51 cents per mile for business miles driven
      • 19 cents per mile driven for medical or moving purposes
      • 14 cents per mile driven in service of charitable organizations
Source: IRS Rev.Proc. 2010-40 & IR-2010-119 & IRC Section 2001