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Sunday, June 13, 2010

Law - "Legacy for One Billionaire: Death, but No Taxes" (Ripped from the Headlines)

This story from last Tuesday's NY Times bears some similarities to a recent episode of Law & Order, but I was certainly not the first to notice.

First, the Times story: David Kocieniewski reported:

A Texas pipeline tycoon who died two months ago may become the first American billionaire allowed to pass his fortune to his children and grandchildren tax-free.

Dan L. Duncan, a soft-spoken farm boy who started with $10,000 and two propane trucks, and built a network of natural gas processing plants and pipelines that made him the richest person in Houston, died in late March of a brain hemorrhage at 77.

Had his life ended three months earlier, Mr. Duncan’s riches — Forbes magazine estimated his worth at $9 billion, ranking him as the 74th wealthiest in the world — would have been subject to a federal tax of at least 45 percent. If he had lived past Jan. 1, 2011, the rate would be even higher — 55 percent.

Instead, because Congress allowed the tax to lapse for one year and gave all estates a free pass in 2010, Mr. Duncan’s four children and four grandchildren stand to collect billions that in any other year would have gone to the Treasury. * * *

The bonanza in tax savings for Mr. Duncan’s descendants is sure to be unsettling to those who have paid estate taxes on more modest wealth — until Jan. 1 of this year, it applied to any estate valued at more than $3.5 million, taxing only the money exceeding that threshold, or $7 million for a couple’s estate.

Although the tax affects only about 5,500 estates a year, it is such an incendiary issue that when Congress unexpectedly let it lapse at the end of 2009, financial advisers warned that it might play a macabre factor in the end-of-life decisions being weighed by heirs of elderly Americans. Some estate lawyers worried that tax considerations might prompt their clients to keep an ill relative on life support through the end of 2009 to get the favorable treatment — or worse, resist life-prolonging measures to hasten a relative’s demise before the end of 2010. [L&O!]

The one-year lapse in the estate tax was signed into law by President George W. Bush in 2001, an accounting quirk in his package of tax cuts. Although Democrats pledged to close that gap and reinstate a tax for 2010 when they took control of Congress, they failed to reach an agreement last December. The Senate Finance Committee is now trying to forge a compromise that would reinstate the tax, but even if that effort succeeds, it is unclear whether any changes might be retroactive and applied to those who have died so far in 2010.

Many lawyers say Mr. Duncan’s heirs have the means and motivation to wage a fierce court battle to challenge the constitutionality of any retroactive tax.

On June 11 the NY Times ran this column by Paul Sullivan -- some quotes:
THE disappearance of the federal estate tax this year has created confusion and frustration among the wealthy, even among those who stand to benefit from it. And this has sent them in droves to amend documents that they may have to change again next year. * * *

How this boon to tax advisers happened is yet another chapter in the partisan gridlock common to Washington these days. At the end of 2009, Max Baucus, the Montana Democrat who is chairman of the Senate Finance Committee, tried to extend for three months the existing estate tax laws, put in place in 2001. But when that motion failed, the estate tax expired for the first time since 1916.

What this has meant is that the heirs of wealthy people who die this year will owe no taxes. An extreme case, as detailed in an article in The New York Times on Tuesday, is that of Dan L. Duncan, who died two months ago with an estimated wealth of $9 billion. His heirs will inherit his estate without paying the 45 percent tax that was in effect in 2009, billions that would have gone to the Treasury.

But it is possible that next year will bring cases of the other extreme, when the amount exempt from the federal estate tax falls to $1 million, its 2001 level, from $3.5 million in 2009, and the rate rises to 55 percent, from 45 percent.

“Dan Duncan dies and pays nothing, but the guy who dies with his house worth $2 million next year and his estate is going to pay $550,000,” said Lance S. Hall, president of FMV Options, a firm that values estates. “Is that fair?”

While there were rumblings at the beginning of the year that Congress might reinstate the estate tax and make it retroactive to Jan. 1, it has made no progress on the issue. And the death of someone as wealthy as Mr. Duncan makes a retroactive tax unlikely.

“Now we’re way beyond that consideration,” Mr. Kesten said. “This single family could outspend the I.R.S. in litigating this.” * * *

The real problem comes for the merely rich — individuals worth more than $1 million and less than $3.5 million and couples with net worths of $2 million to $7 million who previously did not have to worry about the estate tax. If Congress fails to act again this year, the estate tax laws next year will revert to their levels before 2001, and that could snare a host of people who set up the estate plans on the assumption that there would be no tax when they died.

“If Congress does nothing, there would be a sevenfold increase in the number of estates subject to the tax than if the exemption stayed at $3.5 million,” said John Dadakis, partner at the Holland & Knight law firm.

As the law stands, the heirs of a single person who dies next year with more than $1 million would be subject to a 55 percent tax. (For couples, it is $2 million.) Heirs of that same person, with a $3.5 million estate, would have paid nothing in 2009 but could pay as much as $1.375 million in 2011, depending on the level of planning. And while this wealth may seem high in many parts of the country, it has professionals on the coasts grumbling.

“In the Northeast, where people own their own homes and have owned them for decades and have money in their retirements, there tend to be a lot of millionaires,” Mr. Kesten said. “It would sweep a whole chunk of the upper-middle class into what used to be a fairly elite group.”

Mr. Sullivan's column points out another aspect of the problem:
[T]he assets of people who died under the old estate tax regime were valued at the date of their death for tax purposes. Any capital gains on, for example, stocks purchased decades earlier — which would have been subject to tax if sold — were erased. That is no longer the case, and figuring out what is owed requires determining the original purchase price — however long ago that was.

Without an estate tax this year, the Internal Revenue Code grants an artificial step-up in basis, as it is called, of $1.3 million to be used at the executor’s discretion and $3 million on assets passed to a spouse. The only glitch is the Internal Revenue Service has yet to issue documents to record how this exemption has been applied.

“The absurdity of it all is there is not even an I.R.S. form yet to do this,” Ms. Hader said. “My client who died on Jan. 2. Even if we wanted to comply with the law as it exists now, we can’t.”

“We are aware of the increasing need for direction from the I.R.S. on this issue,” the agency said in a statement. “We will be working closely with the Treasury Department to provide answers as quickly as possible, and, if necessary, to develop a new form.”

While the tax would not be due until April 15, 2011, the problem comes when heirs need to sell something. If they received a long-held position of stock, they might want to sell part of it to diversify their holdings or raise cash. But they would incur a 15 percent capital gains tax on the appreciated amount.

It is trickier for property. John Nuckolls, national director of the private client tax services practice at the accounting firm BDO, said a friend in Iowa inherited a farm from his mother that he wanted to sell. With a basis near zero, it was worth more than the $1.3 million that the I.R.S. step-up in basis would exempt but less than the $3.5 million exemption in 2009. If he sells it this year, he will incur capital gains tax.

But that is little compared with what heirs to a moderately wealthy person may pay if Congress does not act.

Now back to Law & Order. This May 22, 2010 entry from the Wills, Trusts & Estates Prof Blog includes a clip from the May 10th, episode of Law & Order entitled The Taxman Cometh.

Posted by Marcia Oddi on June 13, 2010 07:13 PM
Posted to General Law Related