Every year, the experts at Trusts & Estates pull together an exhaustive roundup of the year’s most important and interesting tax law cases. However, the usefulness of this information isn’t limited to attorneys and other estate planners—advisors can benefit from a familiarity with these updates as well. So, we’ve put together an abbreviated reference for non-lawyers who want to keep up with these changes.
Tax Basis
Surface Transportation and Veterans Health Care Choice Improvement Act of 2015.
This law enacts consistent basis reporting rules and introduces new reporting obligations for executors.
It requires beneficiaries of estates to use the finally determined estate tax value of any property they receive as their income tax basis and imposes a reporting obligation on executors to provide statements of such values to the Internal Revenue Service and all beneficiaries. The kicker is that these statements need to be sent within 30 days of the deadline to file the return (or when it's actually filed, if earlier), which is going to lead to a lot of questions and uncertainty for executors about who is getting what and when.
Charitable Deductions
Estate of Belmont v. Commissioner
The Tax Court denied an estate’s income tax charitable deduction because the amount wasn’t “permanently set aside” because of pending litigation.
Elaine Belmont died owning, among other assets, a condo. In her will, she left a sum to her brother (who lived in the condo at her behest) and everything else to a charity. Her brother brought several claims seeking the right to continue to live in the condo in lieu of the sum he received. While these cases were ongoing, an accountant (with no knowledge of the ongoing litigation) prepared the estate’s tax return and claimed a charitable deduction that included the value of the condo.
The U.S. Tax Court held that the estate wasn’t entitled to a charitable income tax deduction because there was more than a remote possibility, due to the brother’s litigation against the estate, that the amounts allegedly set aside wouldn’t be used for charitable purposes. (If the brother won, he wasn’t going to give the condo to charity, after all.) So, when claiming charitable deductions, make sure the charity will actually receive the amounts claimed.
Gift Tax
Proposed REG 112997
Proposed regulations regarding transfer taxes imposed on U.S. citizens and residents relating to gifts and bequests from certain expatriates.
This tax is intended to prevent the loss of tax revenue from expatriates who move to avoid U.S. gift or estate tax. It applies to any transfer that meets the requirements, regardless of whether the property transferred was acquired by the donor or decedent before or after expatriation.
The tax is imposed on the U.S. citizen or resident (including a domestic trust) that received the gift—not the expatriate.
Any gifts from a “covered expatriate” and any property acquired due to the death of a “covered expatriate” can cause liability. A “covered expatriate” is a person who’s expatriated on or after June 17, 2008 and who, on the date of expatriation: (1) had an average annual net income of at least $124,000 for the previous five years, (2) had a net worth of at least $2 million, or (3) failed to certify under penalty of perjury that he’s complied with all U.S. tax obligations for the five preceding taxable years.
Thus, expatriation may avoid future U.S. income taxes, but gifts and bequests by an expatriate to a U.S. person may still be subject to transfer taxes.
Estate Tax Returns
IRS will no longer issue estate tax closing letters unless requested.
The IRS announced on its website that it will no longer automatically issue closing letters. Instead, it will only issue closing letters for estate tax returns filed on or after June 1, 2015 on request. It suggests taxpayers wait at least four months before making the request and provides a phone number to call regarding requests.
Fiduciary Liability
Rafert v. Meyer
Trustee held liable for breach of trust despite provisions in trust instrument absolving him of responsibility relating to insurance policies.
An attorney was named trustee of an irrevocable insurance trust that owned three life insurance policies. The trust instrument provided that he had no obligation to pay (or ensure payment of) premiums on the policies held by the trust or to notify anyone about nonpayment and that he wasn’t subject to liability in the event of nonpayment. He also had no obligation to furnish annual reports to trust beneficiaries.
There was a snafu with the payment of the premiums and the attorney failed to inform the trustee or beneficiaries of the nonpayment. Thus, the policies lapsed.
The Nebraska Supreme Court held that the terms of a trust don’t prevail over the duty of the trustee to act in good faith and in the interests of the beneficiaries and to keep qualified beneficiaries of a trust reasonably informed about facts necessary to protect their interests.
Many insurance trusts include terms reducing the trustee’s responsibility and liability relating to insurance policies held by the trust. This case is a good reminder that any exculpatory language needs to be communicated to the client. The client needs to decide who’s responsible for maintaining, evaluating and paying for the policies and make an informed decision if he’s going to let the trustee off the hook. And, the trustee still has fiduciary duties, even if the trust instrument says otherwise.
Insurance
Webber v. Comm’r
An individual is found liable for tax on income generated in accounts underlying private placement life insurance policies under the investor control doctrine.
Jeffrey Webber established a grantor trust that purchased private placement variable life insurance policies from Lighthouse, a Cayman Islands company, on the lives of two elderly relatives. He and his family members were the beneficiaries of the trust.
The premium payments, less expenses, were held in separate accounts by the trust and invested. Lighthouse didn’t provide investment management services for the accounts but permitted the policy-holder to select an investment manager from an approved list. The policy-holder was prohibited from directing investments and was only allowed to give general investment objectives and guidelines.
However, Jeffrey, who managed a series of private equity partnerships, made investment recommendations by phone or email to his attorney and personal accountant, who then relayed them to the investment manager. The investment manager for the accounts didn’t review, research or recommend any equity investments.
The court found that Jeffrey could not benefit from the favorable tax treatment normally afforded life insurance and annuities, which is based on the premise that the insurance company owns the investment assets underlying the policy, because he had, in practice, full control in selecting investments for the separate accounts by directing the investment manager to buy, sell and exchange securities and that the investment manager took no independent initiative to research or perform due diligence with any of the investments, none of which were publicly traded.
Portability
Treasury Decision 9725
On June 16, the IRS issued final regulations regarding portability of the federal estate tax exemption.
Of particular note is that estates that are under the exclusion amount and not otherwise required to file a return are now granted an extension of time to formally elect portability. The regulations also clarified that the executor of an estate who timely files a complete return doesn’t need to file a separate protective election to confirm the amount of the deceased spouse’s unused exemption (DSUE). A timely filed return is sufficient to elect portability, and if factual elements of the return change (for example, a deduction is ultimately allowed), the recomputed amount of DSUE will be available without additional filings or any protective election. Similarly, when a non-citizen spouse becomes a citizen, if the portability election was made, the amount of DSUE will be adjusted and become available to the spouse on becoming a citizen.
Same-Sex Marriage
Obergefell v. Hodges
By a 5-4 decision, the Supreme Court, in the consolidated case of Obergefell et al. v. Hodges et al., ruled that state laws that prohibit same-sex marriage are unconstitutional as a violation of the due process and equal protection clauses of the 14th amendment. Also unconstitutional are laws prohibiting a state from recognizing a valid out-of-state same-sex marriage.
With this opinion, the debate over whether a state’s anti-same-sex marriage laws are constitutional is now over. In many states, however, the aftermath in applying this “new marital order” is just beginning.
NPRM Reg. 148998-13
Proposed amendments modify statutes to be inclusive of same-sex couples
The IRS released proposed regulations that reflect the holdings of the recent Supreme Court cases (Windsor and Obergefell), that require that same-sex couples be treated the same under the IRC as opposite-sex couples. Terms indicating gender (such as “husband” and “wife”) are to be interpreted in a neutral way to include same-sex spouses. The proposed regulations amend the Internal revenue Code to provide that for federal tax purposes, “spouse,” “husband” and “wife” all mean an individual lawfully married to another without regard to gender. In addition, if a marriage is recognized by a state, it will be recognized for federal purposes. However, this recognition doesn’t apply to registered domestic partnerships, civil unions or other similar relationships that aren’t denominated as marriages.
State Income Tax
The Kimberley Rice Kaestner 1992 Family Trust v. North Carolina Department of Revenue
A North Carolina state court declared that a statute that taxed the income of a trust of which the beneficiaries were state residents, but whom held other connections to the state, was unconstitutional under both the federal and state constitutions. The statute levied a tax on the “amount of taxable income of the estate or trust that is for the benefit of a resident.” The court explained that the residency of the beneficiaries alone wasn’t sufficient to subject the trust to tax.
In our mobile society, where trustees, beneficiaries and assets move from state to state, these issues are becoming increasingly important. Planners and advisors need to keep their eyes open for potential new or additional state income taxes caused by a change in the residency of the trustees, beneficiaries and/or the location or situs of assets.
2016 Inflation & Other Adjustments
Rev. Proc. 2015-53
The IRS set forth certain inflation-adjusted tax items for 2016. The adjustments include, but aren’t limited to, the following, effective Jan. 1, 2016:
- The annual exclusion for gift tax purposes remains at $14,000.
- The first $148,000 (up from $147,000) of qualifying gifts to a non-citizen spouse aren’t included in the year’s total amount of taxable gifts.
- The unified credit against gift and estate tax will be $5.45 million (up from $5.43 million).
- The Generation-skipping-transfer tax exemption increases to $5.45 million (up from $5.43 million).
