The WSJ Weighs-in On the Estate Tax Debate

The Wall Street Journal recently ran a special report on the future of the federal estate tax.  Among the articles are recommendations from various estate planning experts providing advice for how people should be planning given the uncertainty surrounding the estate tax. The most common suggestion is for those with larger estates to take advantage of the temporary "estate tax free" and low interest rate environment to shift wealth between generations this year.  Some common techniques would include selling assets to Intentionally Defective Grantor Trusts (IDGTs) or transferring assets via short-term Grantor Retained Annuity Trusts (GRATs).  Using short-term GRATs may be a limited opportunity, as Congress is considering limiting or eliminating this strategy.

Life Estate Deed or Trust? It's No Contest!

In my practice, one of the most commonly requested legal services is for the preparation of a deed transferring the client’s home to their children, with the parents reserving a “life estate” interest in the home.  The general purpose of such an arrangement – often referred to as a “life estate deed” -- is to protect the home if the parents someday need long-term care assistance and hope to qualify for Medicaid.  However, under virtually any situation transferring a home to a Medicaid Asset Protection Trust (“MAPT”) is a better option than use of a life estate deed.

If successfully implemented, both the life estate deed and the MAPT will protect a primary residence so long as the homeowner does not apply for Medicaid long-term care coverage for at least five years from the date the strategy is implemented.  But the MAPT has a number of significant advantages over the life estate deed that makes the MAPT the strategy of choice.  Here are some of the key differences:

• If the home is sold after being conveyed to the MAPT, the entire capital gain will qualify for the capital gain exemption that is available only to owners of a primary residence ($250,000 exemption for individuals, $500,000 for married couples). By contrast, if the home is sold after being conveyed via a life estate deed, the portion of the home that has been transferred to the “remainder beneficiaries” – that is, the children – will be subject to capital gains tax.

 Example:  A 73-year-old widow transfers her home to her two children, who both reside in New York, using the life estate deed technique.  Two years later the widow decides to sell her home and move in with one of her children.  The home, which has a cost basis of $50,000, is sold for $250,000.  Under the federal government’s life estate tables, the children’s remainder interest is about 48% of the total property value. Since the capital gain from the sale is $200,000, the children will have to pay a capital gains tax of about $20,000 (based on the approximately 20% state and federal capital gains tax on the children’s $96,000 portion of the gain). A similar sale from a MAPT will result in the payment of no capital gains tax, as the entire sale proceeds are deemed to “belong” to the widow for capital gains tax purposes.

• A transfer to children via a life estate deed is typically an irrevocable transfer.  If a parent later has a falling-out with a child, the parent will be unable to “undo” the transfer made under the deed.  By contrast, a properly structured MAPT will include a “limited power of appointment” that permits the parent to change the trust beneficiaries during the parent’s lifetime, and retains for the parent the right to decide who receives the trust assets after the time of the parent’s death. 
• If a parent someday enters a nursing home and the children elect to sell the parent’s residence, with the life estate deed technique Medicaid will be entitled to reimbursement for the portion of the sale proceeds equal to the value of the parent’s remaining life estate interest at the time of sale.  So, if a 75-year-old is on Medicaid and the home is sold for $250,000, Medicaid will be entitled to reimbursement for the parent’s 52% portion of the sale proceeds (or $130,000). In contrast, there is no Medicaid reimbursement requirement if a residence held by a MAPT is sold while the parent is receiving Medicaid assistance.

Book Signing Party on Tuesday!

A reminder:  we will be hosting a book signing party this Tuesday, September 14, 2010 from 4:00 p.m. to 6:00 p.m. at the BSRB Education Center, 10 Matthews Street, Goshen, New York.  Each attendee will receive a personally signed copy of my contributory book, The Complete Guide To Estate & Financial Planning in Turbulent Times. 

Please join us!

Will Congress Act on Estate Tax Reform in 2010?

According to a report in The Hill, Sen. Chuck Grassley (R. Iowa) predicts that Congress will act before the end of 2010 to prevent a return of the federal estate tax in 2011.  Unless Congress acts this year, an individual decedent's federal estate tax exemption will be only $1 million as of January 1, 2011.

Grassley, who is the ranking Republican on the Senate Finance Committee, believes that Congress will enact compromise legislation that will provide for a $3.5 million per person federal estate tax exemption.  While Republicans have been strenuously advocating to make estate tax repeal permanent, Grassley's prediction appears to signal that the Republicans are finally ready to compromise, rather than see the estate tax exemption revert back to the same $1 million amount that was in effect back in 2000. 

Of course if Republicans make significant gains in the House and Senate in November's election as many pundits are predicting, they may well take a harder line on this issue.  But Grassley's comments reflect the reality that, regardless of the results in November, the Democrats will retain control of Congress through the end of this year.  Even if the Republicans gain control of both the House and the Senate, without estate tax reform this year -- which will require a compromise with the Democratic leadership -- the federal estate tax exemption will automatically revert to $1 million in January, and would remain so for such period of time until a new bill were to pass both the House and the Senate.  And, even if a Republican majority were to succeed in passing a bill providing for significantly larger exemption amount -- say $5 million per person, or even complete repeal -- such legislation would almost certainly face a Presidential veto.

Given that Republicans were unable to enact permanent estate tax repeal throughout the Bush years -- during a time when Republicans controlled both the House and the Senate as well as the White House -- it seems plausible that the Republicans would agree to a $3.5 million exemption that would be effective as of January 1, rather than risk the wrath of their supporters were the exemption to revert to the $1 million figure, which would be the case as things currently stand. 

There seems very little risk to Republicans to agree to such a compromise, which would almost certainly take place after the November elections.  While the Republican "base" might howl at the thought of any accommodation with the Democrats, Republicans in Congress would certainly continue to press for complete estate tax repeal in the months and years ahead.  Depending upon future election results -- especially in the 2012 presidential election -- Republicans might finally realize their long-held dream of permanently killing the federal estate tax.  In the meantime, if the $3.5 million exemption is instituted as of January 1, they will have at least ensured that all but the wealthiest American families will be exempt from paying any federal estate tax.

Click here to read the article.