Estate Tax

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Anyone who has seen the current Broadway hit Hamilton knows that we are a nation of immigrants. Moreover, many U.S. persons who moved here from elsewhere have parents back in their home country.

When those “foreign” parents pass away and leave assets to their U.S. children, those assets become subject to the U.S. estate tax system in the children’s estates, where ultimately they can be taxed at a 40 percent federal tax rate (plus state estate taxes) when a child dies.

The adverse tax result that follows from foreign parents leaving their assets outright to U.S. children can be avoided with advance planning. Often, foreign parents can incorporate trust planning into their own estate planning documents. If assets pass to a properly structured trust for the benefit of a child rather than outright to the child, the assets in the trust may not be subject to estate tax in the child’s estate.

New York estate tax practitioners often consult with foreign advisors to effectuate this kind of planning, and it is becoming more important given the amount of immigration and investment in the New York area in recent years.

A parent can incorporate this type of trust planning—often called “dynasty trust” planning—in a Will that is valid in his or her home jurisdiction. The Will would include provisions to create the dynasty trust upon the parent’s death. To accomplish this, the U.S. trusts and estates lawyer can work with foreign counsel to (1) confirm that the “home country” law allows such a structure and (2) provide the dynasty trust language that will reflect the client’s goals and satisfy U.S. tax law requirements. For example, the trust can allow the child to be sole trustee of the trust created for his or her benefit, and permit distributions to the child and his or her descendants subject to ascertainable standards (i.e., health, education, maintenance and support) so that the trust assets are not included in the child’s estate. The trust can include powers of appointment and several other tools that allow for greater flexibility in the trust.

As an alternative to including the dynasty trust plan in a foreign parent’s Will, the parent could establish and fund a trust during lifetime to carry out his or her objectives. The U.S. tax practitioner can assist with the U.S. tax advice relating to such a trust.

If established outside the United States, such a trust usually will be structured to be a “foreign grantor trust.” This is a trust that, under the U.S. grantor trust rules (Internal Revenue Code §§671-679), is not treated as a separate taxpayer from the grantor. The trust is disregarded for U.S. income tax purposes, and the foreign grantor reports all items of income, deduction, gain, loss, credit, etc. on his or her own tax return, if any.

It is often simpler to structure this type of trust as a foreign grantor trust, rather than a foreign non-grantor trust that is treated as a separate taxpayer. A foreign non-grantor trust with U.S. beneficiaries has a number of tax reporting requirements, and also can be subject to punitive income tax rules (known as the throwback rules) when funds are distributed to U.S. beneficiaries. Thus, the parent’s trust is often best structured as a foreign grantor trust while the parent is alive. When the parent dies, the trust becomes a non-grantor trust, and the U.S. children generally will move the trust to the United States at that time (pursuant to a “change of situs” provision in the trust) so that it becomes a domestic, U.S.-situs trust.

In order to qualify as a foreign grantor trust, the trust must be fully revocable by the grantor. Internal Revenue Code §§672(f)(1) and (2). (Note that foreign trusts do not qualify as grantor trusts under the same rules as domestic trusts). This is often a desirable structure for U.S. children and their foreign parents. The foreign parent is committing to a structure that he or she can revoke or change at any time, while the U.S. child has the benefit of the parent’s proactive tax planning.

The foreign trust generally will have a bank or trust company acting as trustee in the jurisdiction of choice (e.g., BVI or Cayman Islands). The trust may have a family member named as a “trust protector” who has the right to remove and replace the trustee and make other changes to the trust. The trust may own the stock of an investment company that holds the assets transferred into this structure, and a family member can act as director of the company to manage the investments.

The substantive provisions of the trust permit distributions to children and grandchildren in the discretion of the trustee (which provides an asset protection benefit to the beneficiaries). The trust can continue in this fashion for many generations, and should not be subject to U.S. estate or generation-skipping tax.

As the parent/grantor of the trust is also included as a trust beneficiary, distributions from the trust can be made to the parent during his or her lifetime. In practice, if the parent wants funds in the trust to be distributed to a child, it is often best for the parent to withdraw funds from the trust and distribute them directly to the child. Among other things, this makes the U.S. tax reporting of the gift on a Form 3520 simpler.

Under certain circumstances, the foreign parent may wish to establish a U.S.-situs grantor trust rather than a foreign trust. This may make sense, for example, if the foreign parent has U.S. assets that will be transferred to the trust.

This article provides just a brief treatment of this issue and of course there are many additional complexities. The trusts and estates practitioner must consider, among other things, (1) whether home country law allows foreign parents to leave assets in this manner, (2) various reporting requirements for foreign trusts with U.S. beneficiaries, (3) trustee selection and fees, (4) numerous drafting issues to build maximum flexibility into long-term trusts, and (5) compliance with U.S. income and estate tax laws. Yet the tax saving opportunity for clients in this situation is substantial, and should be considered by all foreign parents leaving significant assets to U.S. children.

Reprinted with permission from the January 17, 2017 edition of The New York Law Journal© 2017 ALM Media Properties, LLC. All rights reserved.  Further duplication without permission is prohibited. ALMReprints.com – 877-257-3382 – reprints@alm.com

The New Jersey Tax Appeal Filing Deadline is April 3rd.

In the upcoming weeks property owners will be receiving their annual property tax assessment notices (postcards) from the municipal assessor’s office. Receipt of these assessment notices indicates that the time has arrived to determine whether a tax appeal is warranted for the 2017 tax year.  Despite what can best be described as uneven improvement in the real estate market across various commercial segments, the need to carefully evaluate property tax relief opportunities continues as commercial property taxes remain the largest single expense component affecting a property owner’s bottom line. The 2017 tax appeal filing deadline is April 3, 2017, unless a town-wide reassessment or revaluation is in place, in which case the deadline is May 1, 2017.

Consequently, it behooves commercial property owners to review their property tax assessments with experienced professionals now in order to ensure that these assessments are in line with the property’s true value.  Because New Jersey law “freezes” assessments for a period of two (2) years, at levels agreed to between property owners and municipalities in resolution of appeals filed with the County Tax Boards or State Tax Court, or alternatively as a result of judgments reached by these bodies on the merits, the tax appeal vehicle can be an effective means of fixing assessments while the market is trending in an upward direction. In addition, because assessments are generally not disturbed until a town-wide revaluation or reassessment program is implemented (usually every 5-10 years) there is a real prospect that a lower assessment achieved as a result of a successful appeal this year could have real lasting value and actually provide savings to taxpayers for many additional years beyond the two (2) freeze years guaranteed by law.

As a result, there continues to be real opportunities for property owners to realize significant tax savings and lock in present values for the foreseeable future.  Commercial property owners are therefore encouraged to consult with their real property tax professionals to determine if a tax appeal would be warranted in their particular case in 2017.

Please feel free to contact Carl A. Rizzo at crizzo@coleschotz.com or by telephone at (201) 525-6350 with any questions.

 

On October 14, 2016, Governor Christie signed into law a transportation funding bill that also included the repeal of the New Jersey Estate Tax. Here is what you need to know:

  • The New Jersey Estate Tax repeal will be effective as of January 1, 2018. The current $675,000 exemption will increase to a $2 million exemption on January 1, 2017. The Estate Tax will be eliminated as of January 1, 2018.
  • The New Jersey Inheritance Tax is still in effect. This is a tax imposed on transfers to beneficiaries who are not spouses, parents, children or grandchildren (i.e., nieces, nephews, siblings, friends, etc.) New Jersey Inheritance Tax rates start at 11% and go as high as 16%.
  • As part of the new law, there is a tax break for retirees. There will be an increase in the New Jersey gross income tax exclusion on pension or retirement income over four years (in 2020) to $100,000 for couples, $75,000 for individuals, and $50,000 for married taxpayers who file separately.
  • On January 1, 2017, the sales tax will be reduced from 7% to 6.875% and will be further reduced to 6.625% on January 1, 2018.

Now that the repeal has been enacted, is New Jersey an attractive state to die in? We have counseled many clients over the years that moving to Florida could save significant estate taxes. With the New Jersey Estate Tax repeal (effective in 2018), some of the advantages enjoyed by Floridians can now also be enjoyed by New Jersey taxpayers (namely, no estate tax in either state).

However, moving to Florida also saves income tax, as Florida does not impose state income tax. New Jersey still does, so this remains a major advantage when moving to Florida. All income from sources outside New Jersey will not be taxed in New Jersey if you reside in Florida. If you reside in New Jersey, you will still pay state income tax on all income.

Also, if you bequeath assets to beneficiaries who are not descendants and you reside in New Jersey, you still will trigger a New Jersey Inheritance Tax, as this tax was not repealed.

Despite the New Jersey Estate Tax repeal, it is still very important to make sure your estate is in order if you reside in New Jersey. There are significant federal estate tax issues to plan for, and many non-tax issues which need to be considered and properly addressed.

The IRS has at last issued long-anticipated proposed regulations under Code §2704.  We perceive the proposed regulations as an attempt by the IRS to curtail the use of discounts – such as minority interest and lack of marketability discounts – in valuing transfers of interests in family-controlled entities for gift and estate tax purposes.

“Family limited partnerships” – that is, family investment entities usually structured as LLCs or limited partnerships – have been a popular estate planning technique for years.  Generally speaking, a client can transfer non-voting, non-marketable interests in these types of entities to children or a trust, and claim a valuation discount due to the restrictions that apply to the interest transferred.

Code §2704 provides that certain “applicable restrictions” on ownership interests in family entities, ie, entities where the transferor and family members control the entity, should be disregarded for valuation purposes.  The statute also permits the IRS to issue regulations providing for other restrictions (as determined by the IRS) to be disregarded in determining the value of a transfer to a family member, if a restriction has the effect of reducing the value of the transferred interest but does not ultimately reduce the value of such interest to the transferee.

The proposed regulations make two overarching changes.  First, changes under Code §2704(a) create new rules relating to a lapse of a liquidating right.  These changes are less relevant, at least in our practice, as we generally do not structure entities to include liquidation or other rights that lapse.

Second, changes under Code §2704(b) create a new concept of “Disregarded Restrictions.”  Under the proposed regulations, a restriction that will lapse at any time after the transfer, or a restriction that may be removed or overridden by the transferor (or the transferor and family members acting together) will be disregarded for gift and estate tax valuation purposes.  This is the case even if the restriction on the interest is pursuant to state law rather than a governing business agreement.  There are certain exceptions – for example, an owner’s right to liquidate or “put” his or her interest to the entity and receive cash within six months is not considered a “disregarded restriction.”

The effect of this rule appears to be that it would eliminate minority interest discounts, because the holder of any interest would be deemed to be able to liquidate his or her interest in the entity without restrictions.  The effect of the proposed regulations on lack of marketability discounts is unclear, although it seems the IRS similarly could argue for a small or zero lack of marketability discount on the theory that the holder of the interest is deemed to be able to liquidate the interest.

Thus, if the proposed regulations are adopted in their current form, they likely will increase the value for gift and estate tax purposes of transfers of interests in family-controlled entities.

The proposed regulations are controversial.  Commentators already have questioned whether the Treasury has exceeded its statutory authority in issuing the proposed regulations.  The proposed regulations are (at least in this author’s opinion) complicated and ambiguous, and perhaps unfair.  For example, if a client creates an LLC to purchase and manage a commercial property, and the client transfers an interest in the LLC to his or her child, and the interest is subject to typical restrictions on sale of the interest or the ability of a member to liquidate (largely because the asset owned by the LLC is illiquid and perhaps leveraged), then it seems that the true value of the interest transferred to the child would be reduced due to these restrictions (think about what a willing buyer would really pay the child for the LLC interest); however, under the proposed regulations, the value of the LLC interest transferred would be artificially inflated for gift tax purposes.

The proposed regulations are not effective until they are finalized.  Treasury has requested written comments by November 2, 2016 and a public hearing on the regulations is scheduled for December 1, 2016.

Prince was not the first famous person to die without a Will.  Others who died intestate include:  Abraham Lincoln, Ulysses S. Grant, Howard Hughes, Martin Luther King, Jr., Sonny Bono and Pablo Picasso.  Dying intestate is usually a huge financial mistake.

In Prince’s case, as in similar cases of intestacy, dying without a Will causes several problems.  First, there is confusion among the family as no one knows what his true wishes were.  Confusion often leads to litigation.  Second, the costs are often greater because the steps to administer the estate are more involved.  For example, an administrator usually needs to pay for and post a bond (based on the value of the estate), whereas an executor named under a Will generally does not.  Third, Prince’s assets will pass under the rules of “intestacy” (in this case the law of Minnesota), which often is not the distribution (to family or charity) that the decedent would have wanted.  This can be especially problematic for single people or those in second marriage situations.  Fourth, if minor children are involved, a court proceeding will be necessary to name guardians for them.  And, without a Will, the decedent makes no provision for taxes and expenses, which can result in large tax liabilities or other unintended consequences.

All of these outcomes are easily avoidable.  In Prince’s case, the estate appears to consist largely of real estate and intellectual property rights (ie, his catalog of published and unpublished music).  From the tax planner’s perspective, this means it is largely illiquid, which is problematic.  The federal estate tax, imposed at a rate of 40%, is due nine months from the date of death.  Although it may take months to determine whether Prince actually had an estate plan, at the moment it appears the artist took few, if any, steps to plan for liquidity to pay taxes or to reduce his estate tax exposure.

Outdated Wills also present problems.  Fiduciary choices (executor, guardian, trustee) often change over time.  In addition, our choices as to who should inherit our property also may change over time.  We all know a story about someone who unexpectedly (or undeservedly) inherited under a Will, or someone who was unintentionally left out.

In a notable case in our office, we represented the estate of a deceased estate planning attorney who did not update his own Will for over 40 years.  The document led to significant litigation due to outdated tax planning and unanticipated tax allocations, among other problems.

Most of us, therefore, should have up-to-date Wills.  The Will governs the disposition of your assets and ensures that these assets pass to your family and loved ones in the manner you desire.  A Will usually includes tax planning, that is, setting up a structure that minimizes federal and state estate taxes.  You appoint an executor, the person who is responsible for carrying out your wishes.  You may also appoint guardians for minor children, and trustees for any trusts created under the Will.

Basic estate planning documents also include a power of attorney and health care directive – documents to plan for incapacity by naming an agent to make decisions on your behalf if you are unable.  Estate planning documents should be reviewed by an attorney every three to five years or following a significant life event.

Proper estate planning is a gift to your family.  It accomplishes your objectives, avoids confusion, saves money, minimizes taxes, and gives you the peace of mind of knowing that your affairs are in order.