How did the Fiscal Cliff Compromise Impact Estate Planning?

It has been a few weeks since the world was allegedly going to end - either on the Mayan Calendar or Channel 9's Fiscal Cliff Calendar Countdown Clock- and the U.S. and the world survived. We also got an answer to the question of whether there would be an estate tax fix for 2013? The answer is "yes." But, what was that answer?

Here is the impact of the American Taxpayer Relief Act of 2012 (ATRA) compromise as it relates to estate planning:

  • Extended the inflation-adjusted individual $5 million gift, estate and generation-skipping transfer (GST) tax exemptions that were put in place in 2010. For 2013, inflation adjusted exemption amount for the three taxes will be $5.25 million.
  • Raised tax rate on estates with assets above the gift, estate and generation-skipping transfer (GST) tax exemptions levels to a top rate of 40%. This is an increase from 35% top tax rate applied for estates in 2011 and 2012.
  • Made permanent portability for married couples. As long as a federal estate tax return is filed in the death of the first spouse, portability allows the surviving spouse to use the unused federal estate tax exemption of the first spouse to die. If both spouses die in 2013 and the portability election was made in the first to die's estate taxes that would result in the ability to shield $10.5 million in combined assets from federal estate taxes.
  • Retained the ability to deduct state estate taxes on the federal estate tax returns. In other words, a gift to those states that apply a state estate tax onto resident's estates. Those states also tend to complain that their state estate tax make their states less attractive to older residents.
  • Retained, for the time being, the current tax and legal status of grantor retained annuity trusts (GRATS), valuation discounts, unlimited-term generation-skipping trusts and other high-level estate planning techniques. All of these techniques have targets on their back and could be reduced or eliminated in the upcoming negotiations.

In addition to ATRA raising the income tax rates on affluent Americans - those making more than $400,000 (single) and $450,000 (married) - ATRA also enacted legislations that impacts other areas of the income tax that cross-over with estate planning. Those changes include:

  • Reinstated the tax-free distribution from an individual retirement plan directly to a qualified charity. The ability to make this charitable transfer technically expired at the end of 2011. But, ATRA included a special provision permitting individuals to make a payment directly to a charity in and still be treated as a tax-free 2012 distribution from the IRA. This payment needs to be made by the end of January. So, you better get on it if you want to take advantage of this transfer.
  • Eliminated the need for the Alternative Minimum Tax "patch" that occurred every year by adding an inflation index to the AMT exemption levels.
  • Reintroduced back into the tax code limits on itemized deductions (PEASE) for adjusted gross income over $250,000 (single), $275,000 (head of household) and $300,000 (joint filers). In the past, PEASE applied across the board on all of a person's itemized deductions including donations to qualified charities.
  • Reintroduced back into the tax code phases out personal exemptions (PEP) for adjusted gross income over $250,000 (single), $275,000 (head of household) and $300,000 (joint filers).
PEP and PEASE are rather nasty tax provisions. Each slashes a person's deductions and silently increases a person's effective tax rate e.g. a married couple having an AGI of $350,000 would be in the 35% tax bracket but would have a much higher effective and marginal tax rates. Looking into my estate planning crystal ball, with PEASE reintroduced, it will likely mean a reduction in clients establishing Charitable Lead Trusts and other similar entities because of the reduced tax savings that occurs because of PEASE. Charities were probably one of biggest under-reported "losers" coming out of ATRA's enactment.

However, there are still three more big fiscal issues (debt ceiling increase, remaining 2013 budget reconciliation and sequestration) confront the federal government over the next 60-90 days. Anything can happen and the above estate and tax provisions could all change by the first day of spring.


Basics of Estate Planning: Virginia's Aid and Direction

November's Basics of Estate Planning article on the role of the personal representative emphasized the important responsibilities that representatives bear, as fiduciaries of the estates that they serve. Given the risk of personal liability for performing their duties incorrectly, many representatives choose to seek professional advice on complex matters; these services are usually paid for by the estate itself.

Sometimes, however, professional advisors cannot give a definitive answer to a representative's questions. For instance, the will may include confusing language that allows for multiple interpretations of the author's intent. Or the estate's administration may raise issues that have not been fully addressed by the law. In situations like these, Virginia law allows the personal representative to petition the court for a decision on the matter. This petition is called a "suit for aid and direction."

To start the process, a suit for aid and direction is filed in the Circuit Court where probate proceedings were commenced. All parties who may have in interest in the matter must be named as parties to the suit. Unlike a typical lawsuit, the personal representative does not argue for a particular outcome. Instead, she presents to the court all the relevant information and documents in a neutral manner. The court then enters an order deciding the matter.

Since a suit for aid and direction can protect a personal representative from personal liability at no personal cost, one might expect to see cautious representatives seeking the court's guidance for every major decision. Fortunately, Virginia law disallows such a time- and money-consuming approach. Courts will allow a suit for aid and direction only when there is genuine doubt about an issue involving a legal determination (e.g., "how should this ambiguous will clause be interpreted?" or "Does the decedent's estate actually own this asset?"). Nonetheless, when aid and direction is available to settle a real question, the personal representative would be well advised to take advantage of this useful proceeding.

Update on Estate of the Month: Junior Seau's Estate's Sues NFL

In May's Estate of the Month on Junior Seau, I discussed the potential steps a personal representative would need to take if the decedent died a wrongful death. So, with all the concussion news coming out of the NFL and the recent medical report that found symptoms of chronic traumatic encephalopathy ("CTE") in Junior Seau's brain scans, it should come as no surprise that litigation has arisen.

On January 23, 2013, the trustee of his estate, along with his children and ex-wife, sued the NFL in California State Court. Since, there are already several on-going class action lawsuits filed against the NFL by other ex-players, this litigation will be consolidated with those cases.

I will update you on the matter if it warrants.

Estate of the Month: Dispute Over Famous Painter's Estate Does Not Paint a Pretty Picture

After November's look at The Monkees' Davy Jones, we now turn to a different sort of artist. Thomas Kinkade, a well-known painter, died this past April at his home in California, at the relatively young age of 54. Kinkade's paintings had a very recognizable style: peaceful country settings, sometimes with a cabin or similar buildings, and always glowing with streaks and patches of light. He called himself a "Painter of LightTM. And, yes, he did trademarked that name. Click here for some images of his work. While art critics generally dismissed his work as kitschy and boring, Kinkade achieved enormous commercial success by mass marketing prints of his paintings.

Kinkade's own life, however, was not as simple and untroubled as the subject matter of his paintings. His wife Nanette had filed for divorce in 2010, after 30 years of marriage. At the time of his death, Kinkade was living with his girlfriend Amy Pinto, whom he had been dating for 18 months. According to Pinto, the two had been planning to marry once Kinkade's divorce was finalized.

I'm sure you already know where I'm going with this: since Kinkade's death, his estranged wife and his girlfriend have engaged in a bitter dispute over a portion of his estate. Kinkade's wife presented a valid will from 2000, which directs that his estate be transferred to a living trust he had established in 1997. His girlfriend, meanwhile, produced two handwritten notes, claimed to be from Kinkade. The girlfriend has argued that the notes are valid holographic (i.e., handwritten) wills, in which Kinkade leaves her his house, $10 million in cash, and millions more in original paintings.

Of course, even if the court accepted the notes as valid holographic wills, Kinkade's wife could contest the notes on the ground that Kinkade lacked the necessary mental capacity when he wrote them. This is a very real possibility. The notes are so badly scribbled that the girlfriend had to include a transcript with her court documents (you can see the notes here). Moreover, Kinkade apparently had a severe alcohol problem in his latter years (in fact, his death was caused by an accidental overdose of alcohol and valium). Putting these two facts together, it's easy to question whether Kinkade was actually "of sound mind" in those moments. Perhaps with this in mind, the two parties ended the dispute in December, with a confidential settlement.

We'll never know if Kinkade actually intended to leave part of his estate to his girlfriend. He created this uncertainty by using such a questionable method to record his wishes. According to his girlfriend, he did so on the advice of the family lawyer. If true, that's some terrible legal advice, and an example of why you should seek out an estate planning attorney for these matters.

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