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Uncle Sam’s Payday. The estate tax is in such a state of flux that most estates and trusts these days will not
have an estate tax liability. However, single individuals with taxable assets in excess $1.5 million ($2.0 million
as of January 1, 2006) - and their advisors - need to be concerned about who writes the check for estate taxes
that may be due.
Without careful planning, some very unexpected and unfair results can occur.
Boilerplate language. Too often advisors skip over this crucial point without carefully considering the impact of
the usual boilerplate which often says, in effect, "all estate and inheritance taxes are paid out of the residue of
my estate (trust)".
Unfair, and sometimes unexpected, results can occur from this boilerplate. Consider a recent case in our
practice where an elderly decedent had such a provision in her Will and Trust. The decedent had made a
specific bequest of her Lake Michigan cottage to one of three daughters, with some small specific bequests
to the other two daughters, residue divided equally among the three children. We all know what has
happened to the value of waterfront property. The specific bequest of the Lake Michigan property, valued at
close to $1.0 million, skewed the decedent’s wishes substantially in favor of the daughter who got the
Michigan property. The substantial estate taxes, due as a result of the high value, fell equally on all three
children. So, in effect, the results were very unequal. The favored recipient of the Michigan property got a
windfall because her two sisters had to share in tax properly attributable to her bequest.
Second Marriages and IRA’s. Who writes the check to Uncle Sam and what impact it has on the whole estate
are paramount questions in the case of second marriages, IRA’s, and also family businesses.
Often in these situations, IRA’s go to children, at least in part. Who pays the estate tax on these IRA’s, the
recipient or the widow? What is the impact of substantially appreciated real estate on the tax bill, and who
gets to write the check? In a recent estate planning situation we had to consider this matter, because most of
the liquidity was in an IRA account and the client had valuable waterfront property which he intended to divide
between his spouse and his children. The solution in this case was to require the children from their IRA
benefits and real estate bequests to pay their share of the tax.
Horror Stories - Lurie case. The recent tax court decision in the Estate of Robert Lurie is a graphic example of
horrendous results arising from these difficult questions. The decedent died with a Revocable Trust valued at
roughly $90 million, all of which passed to the Marital Share. Prior Irrevocable Trusts were brought back into
the taxable estate to the tune of $40 million. Key questions - Who writes the check? and, for how much? If the
Irrevocable Trusts have to pay, the tab is $22 million. If the Revocable Trust has to pay, the tab is $48 million
(potentially increased to $83 million). Why the difference?
The hooker in the scenario is that payment by the Marital Trust resulted in a circular calculation, the tax liability
reducing the marital deduction, which in turn increased the taxes, etc. In this case, the estate tried to wiggle
out of the tax allocation provision of the trust and apply Illinois law. Nothing doing, said the Tax Court and
ruled for the government, giving the taxpayer both the rock and the hard place.
The situation could have been easily avoided by a tax apportionment provision in the Trust. Tax apportionment
is the default rule under Michigan law, but is overruled by a lot of boilerplate language that estate planners
use.
What is the solution? The solution is always to carefully consider who writes the check for estate taxes and
what the impact of that decision is going to have on the various beneficiaries and legatees. This problem is
compounded by the frequent changes in the estate tax law that we are experiencing and the fluctuation of
asset values.
A client today does not have to have to $90 million at death, like Mr. Lurie, to face these problems. Anything
over $1.5 million in 2004 and 2005, will bring the same questions to bear. The answer is always to bail out of
the boilerplate, look at all the facts and circumstances and craft a tax payment provision that makes sense to
the family and the client.
Added Note of Caution. Clients with large IRA accounts often don’t consider liquidity as a problem. They see
listed securities in the IRA and think those accounts can be the source of any tax monies, without stopping to
consider the substantial income taxes (and a similar circular calculation) that arises when IRA funds are
tapped to pay taxes. Life insurance may be solution, through an ILIT, especially where a family business,
appreciated real estate, or IRA’s comprise a significant portion of the taxable estate. Remember life
insurance is alive and well when it comes to estate tax liabilities (which do not go away until 2010 and come
back with a roar in 2011).
If you have clients with significant wealth, where you know that an estate tax is likely, don’t wait until your client
dies. Contact Jim Modrall at 941-9660 for experienced help in crafting estate plans to meet the demands of
estate taxes.
©BRANDT, FISHER, ALWARD & ROY, P.C.
This newsletter is provided for informational purposes and should not be acted upon without professional
advice.
| WEALTH CONSERVATION: PROFESSIONAL ALERT Brandt, Fisher, Alward & Roy, P.C. |
| April 2004 ESTATE TAXES - WHO WRITES THE CHECK? by James R. Modrall III, J.D., C.P.A. |
| If you would like to receive future editions of the monthly Wealth Conservation Newsletter directly to your e-mail account, please e-mail our office using the following link: Estate Planning Newsletter |
| Brandt, Fisher, Alward & Roy, P.C. Attorneys at Law |