Most wills in Texas are “self-proved,” making them easier to admit to probate following the testator’s death.  Up until September 1, 2011, this required the testator and both witnesses to sign the will twice.  Last year, the legislature simplified the process.

Background

Unless a will is entirely in the testator’s handwriting, a Texas will must be “attested to” by two witnesses in order to be valid.  But if a will only has the signature of the testator and two witnesses, one of those witnesses must still attend the probate hearing following the testator’s death to provide testimony that the will was executed with all of the necessary formalities.  If neither witness is available to testify, there are alternative methods of “proving up the will.”

When the “new” Texas Probate Code was enacted in 1955, it included Section 59, which introduced the concept of a "self-proving affidavit” to Texas.  After the testator and witnesses sign the will itself, they can then sign an affidavit before a notary swearing to the fact that they all executed the will with the necessary formalities.  If this affidavit is attached to the will when it is offered for probate, no “prove-up witness” is required in the absence of a will contest.

Execution Mistakes

This worked great except for one thing.  Since there were two different places for the testator and witnesses to sign, it was now possible for one or more of them to sign in one place, but forget to sign in the other.  In 1966, the Texas Supreme Court ruled in Boren v. Boren, 402 S.W.2d 728 (Tex. 1966), that if the witnesses signed the self-proving affidavit but forgot to sign the will, the will was invalid.  While this seems odd, the court held that the self-proving affidavit was, in effect, a separate document, and since the will itself didn’t have two witnesses (and wasn’t handwritten), it was not executed with the necessary formalities.

It wasn’t until 1991 that the legislature remedied this by amending Section 59.  Following that amendment, if a situation like that in the Boren case arose, the witnesses signatures on the self-proving affidavit would be considered the required signatures on the will, but the will would no longer be considered self-proved.  While a “prove-up” witness would be required, at least the will could be admitted to probate.

The 2011 Amendment

During the execution ceremony, I often found myself explaining to the clients why it was necessary for them and the witnesses to sign the will twice.  The procedure seemed archaic.  So prior to the 2009 legislative session, the Real Estate, Probate, and Trust Law Section of the State Bar came up with a proposed amendment that allowed the execution of the will and the self-proving affidavit to be combined, so that everyone signed just once.  This wasn’t such a radical a departure from current law -- the Uniform Probate Code, adopted in over twenty states, has contained an optional one-step method for years.  Unfortunately, the 2009 bill ran out of time for passage, so this proposal was included in REPTL’s 2011 legislative package that passed.  (A similar change applicable to guardianship designations did pass in 2009.)

Benefits

In addition to streamlining the execution ceremony, this optional method has what I believe is an additional benefit.  With the traditional two-step method, I can see the possibility that the testator or witnesses, having signed a will once, might think they’re done and fail to sign the second time (i.e., the Boren situation).  But it seems unlikely to me that if a will is prepared for execution with the new one-step method, someone could completely fail to sign the will and yet think they’re done.  In other words, I believe (without any scientific evidence at all) to fewer botched will executions.

Nevertheless, anyone who’s still attached to the traditional two-step method may continue to use it.  I see no reason to think it will ever be phased out as an option.

More Info

If you’d like further information, Attachment 2 to my 2011 legislative update contains the actual statutory language of the revised Section 59.  Attachment 10 contains the form for the new one-step method for will executions.  You can download a copy of that legislative update here.

Background

“Living trusts” designed to avoid probate have not found as widespread acceptance in Texas as in some other states.  This is likely due to our independent administration procedures that allow most estates to be settled with a minimum of court involvement, reducing the advantages of “probate avoidance.”  However, there is one aspect of living trusts that many clients might still find appealing, even in Texas – privacy.

Assets passing under a will generally must be listed on an inventory prepared by the executor and filed in the public probate records.  The inventory includes not only a description of the assets, but also an estimate of their value.  On the other hand, assets placed in a living trust prior to the decedent’s death need not be listed on a publicly-filed inventory.  This privacy advantage may be the sole reason for using a living trust as the client’s primary estate planning vehicle.

There have been several attempts to extend the benefits of this privacy to probate administrations.  For example, in 2009, S.B. 559 would have “sealed” inventories in independent administrations.  That bill got nowhere, fast.

The 2011 Change

The desire for privacy did not go unnoticed by the Real Estate, Probate, and Trust Law Section of the State Bar.  REPTL included a provision in its 2011 legislative package (S.B. 1198, to be specific) that allows an independent executor to avoid filing the inventory in the public probate records if certain requirements are satisfied.  Those requirements are: 

• All debts (other than those secured by liens on real estate) must be paid by the time the inventory is due (including any extensions of the filing deadline).
• The executor must prepare, swear to, and provide a copy of, the inventory to all beneficiaries.
• And the executor must file an affidavit in the public probate records that both of these requirements have been met.

This change can be found in new Section 250(c) of the Probate Code and is effective for the estates of persons dying on or after September 1, 2011.  I have found it much more popular among my clients than I had anticipated. 

Questions About the Effectiveness of this Change

I have received a number of questions from attorneys around the state about the availability of an affidavit in lieu of inventory in independent administrations.  One common question is whether independent administrators may use the affidavit alternative.  Yes.  Section 3 of the Probate Code defines the term “independent executor” to include independent administrators.

However, another question arises from the language most wills contain providing for independent administrations.  Section 145(b) of the Probate Code provides that any person “may provide in his [one sic] will that no other action shall be had in the county court in relation to the settlement of his [two sics] estate other than the probating and recording of his [three sics] will, and the return of an inventory, appraisement, and list of claims of his [four sics!] estate.”  Therefore, most well-drafted Texas wills provide exactly that, e.g., “I direct that no action be had in any court relating to the settlement of my estate other than the probating and recording of my will and the return of an inventory, appraisement, and list of claims of my estate.”

[By the way, did you know that “sic” is abbreviated from the Latin sic erat scriptum, meaning "thus was it written?"]

At least one well-respected probate judge has taken the position that this language in the will requires the filing of an inventory, despite the fact that the Probate Code has now been amended to provide the use of the affidavit in lieu of an inventory.  The argument goes something like this:

• The language of Section 145(b), if incorporated into the will as described above, imposes a mandatory statutory duty on an executor to file an inventory.
• Filing an affidavit in lieu of the inventory under Section 250(c) conflicts with this statutory duty.
• Therefore, the executor may be subject to removal without notice under Section 222(b) of the Probate Code.

I believe that there are a number of problems with this analysis.

• Section 145(b) itself imposes no duty at all on an executor.  It merely outlines language that a person may include in his or her will.
  • To the extent the executor has a duty to file an inventory under Section 250, subsection (c) of that statute expressly provides for the waiver of that duty where the requirements for the affidavit have been met.
  • To the extent the executor has a duty to file an inventory under the language of the will itself, it’s not a statutory duty.  At most, failure to file the inventory is a breach of a duty imposed by the will, not any statute.  (We’ll come back to this potential breach a little later on.)
• Section 145(h) provides that once an inventory has been filed and approved or an affidavit in lieu of inventory has been filed, there may be no further action in the court regarding the supervision of the executor except where the Probate Code “specifically and explicitly” provides for that action.
• There is no statutory procedure for compelling the filing of an inventory once the affidavit in lieu of the inventory has been filed.  In Estate of Bateman, 528 S.W.2d 86 (Tex. Civ. App – Tyler 1975, writ ref’d n.r.e.), the appellate court held that the probate court had no jurisdiction to compel an independent executor to file an amended inventory under Probate Code Section 258 after the originally inventory was filed (and presumably approved).  Section 258 did not “specifically and explicitly” apply to independent administrations.  The same rationale would apply once an independent executor has met the threshold of Section 145(h) by filing an affidavit in lieu of the inventory.
• While Section 222(a) of the Probate Code allows a court to remove an executor for failure to file an inventory, cases like Bateman and Baker v. Hammett, 789 S.W.2d 682 (Tex. Civ. App – Texarkana 1990, no writ), make clear that Section 222, like Section 258, does not apply to independent executors.  Section 222 was not amended to refer to the affidavit alternative because it only applies to dependent executors, and the affidavit alternative is not available in dependent administrations.
• Section 149C of the Probate Code lists the grounds for removal of independent executors.  Section 149C(a)(1) only allows removal if the independent executor fails to file either the inventory or the affidavit in lieu of the inventory.  Where the independent executor files one or the other, this ground for removal is inapplicable.  The recent Texas Supreme Court case of Kappus v. Kappus, 284 S.W.3d 831 (Tex. 2009), makes clear that the list of removal grounds in Section 149C is a pretty exclusive list. 
• As noted above, there may be an argument that the failure of an independent executor to file an inventory may be a breach of a duty imposed by the will.  However, after the Kappus case, there is no room left for an argument that a breach of this potential duty, without more, is grounds for removal.

What is the Executor to Do?

An executor faced with a “demand” by a probate judge to file an inventory after an affidavit in lieu of the inventory faces a choice.  The executor can stand on his or her rights and refuse to file the inventory.  Of course, this may make the judge unhappy.  But I doubt there’s much the judge could do about it.

Or, the executor can file the inventory that’s already been prepared and distributed to the beneficiaries.  I don't think the judge has jurisdiction to approve the inventory once the affidavit has been filed, but this will keep the judge happy.  But then what if one of the beneficiaries complains about the unnecessary waiver of privacy interests?

What is the Attorney to Do?

I do not think the attorney should just decide what’s best and make this decision for the executor.  If the executor has a statutory right to file the affidavit in lieu of the inventory in order to further the estate’s privacy interests, the attorney has no right to unilaterally waive that interest just to maintain good relations with the judge in future matters (especially when those matters may have nothing to do with the current client).  This is, after all, the executor’s decision, not the attorney’s decision.

What the Heck is the Affidavit Supposed to Look Like?

If you’re wondering what the new affidavit in lieu of inventory should look like, you’ll find a suggested form as one of the attachments to my 2011 Texas legislative update.

Again, Happy Valentine’s Day!

Here’s what the IRS has done:  

• If a large 2010 estate is going to “opt out” of the estate tax, the new deadline for filing Form 8939 (the special carryover basis form) is now Tuesday, January 17, 2012.  (The previous deadline was November 15, 2011).  No form needs to be filed to take advantage of this new due date.
• If a 2010 estate is not opting out but planning to file Form 706 (the estate tax return), the estate may obtain an automatic extension of time to file the return (by filing Form 4768) until 15 months after the later of (i) the date of enactment of the 2010 tax act or (ii) the date of death.  This means that 2010 estates requesting the extension will have until at least Monday, March 19, 2012, to file the return and pay any estate tax due.  Normally, Form 4768 results in an automatic six-month extension of the filing deadline, but not the payment deadline.  But in this case, filing the extension request will result in an automatic waiver of late-payment penalties (but not interest from the original due date).
• Since Form 8939 may affect the capital gains reportable by beneficiaries inheriting property from a 2010 decedent who then sell the property in 2010, special penalty relief is provided in the event they improperly report gain or loss because they did not know whether the estate made the carryover basis election.

Further details can be found in Notice 2011-76.  You can find it on the IRS website here.

In 1963, the legislature charged the Texas Legislative Council with the task of making a complete, non-substantive revision of Texas statutes into codes.  Our current Probate Code isn’t one of those “codes” since it was enacted before the codification effort began and doesn’t comply with modern Texas code organizational and stylistic principles.  The Probate Code was one of the last subject areas to be “codified” when the Legislative Council started its Probate Code codification project in 2006.

That project led to the passage of the decedents’ estates portion of the Estates Code in 2009.  (The original name for the new code was the “Estates and Guardianship Code,” but one of the authors of the bill felt that new name was a mouthful, so the name was shortened to just the “Estates Code” prior to its passage.)  In 2011, the balance of the Probate Code (primarily the guardianship provisions) was added to the Estates Code.  All of the new Estates Code goes into effect January 1, 2014 (so the legislature will still have time in the 2013 session to fix any errors that are discovered).  

Professor Gerry W. Beyer of Texas Tech University School of Law has just posted his compilation of the entire Estates Code, including both the 2009 and 2011 nonsubstantive bills, along with any substantive changes made in either session.  He has also included conversion charts from the current Probate Code to the new Estates Code, and vice versa.  

You can find the link to his version of the new Estates Code here.

One of these provisions deals with the transfer of a guardianship from one county to another.  Following the transfer, the bond must be modified to reflect the new court, and there must be a hearing within 90 days to determine whether any terms of the original guardianship should be modified. 

The other deals with problems arising from guardianship proceedings in more than one state.  If a foreign guardian desires to transfer the guardianship to Texas, the application should include certified copies of all papers filed in the foreign proceeding, and the Texas court must determine whether any terms of the original guardianship should be modified. 

A Texas court may delay further action in a guardianship proceeding if a subsequent proceeding is filed in another jurisdiction where venue is proper.  The preference of a proposed ward who is 12 years of age or older becomes a factor for the court’s consideration. 

If at any time the Texas court determines that it has acquired jurisdiction because of unjustifiable conduct, the court may: 

1. decline to exercise jurisdiction;
2. impose an appropriate remedy for the health, safety, and welfare of property or prevent a repetition of the unjustifiable conduct; or
3. continue to exercise jurisdiction after considering whether all parties have acquiesced to jurisdiction, whether Texas is a more appropriate forum, and whether the other court would have jurisdiction.

If the Texas court determines that it has jurisdiction because of unjustifiable conduct, the court may assess costs against the party engaging in that conduct.

(Please don’t ask me to explain the relevance of these provisions to a “fiscal matters” bill.)

S.B. 1 was signed by the Governor July 19^thand is effective September 28^th.

We’ve posted an updated legislative update (dated July 19^th) that reflects the changes included in S.B. 1.  You’ll find it in the usual place.

Today, we’re posting a revised version of our legislative update (dated June 18^th) that reflects the Governor’s action on all of the legislation described in the paper relating to probate, guardianships, trusts, powers of attorney, and other areas of interest to estate planning and probate practitioners.  You can download the legislative update here.

As noted in our June 2^ndpost, while it’s theoretically possible that the Legislature could consider some of the bills that failed to pass during the current First Called Session, it’s highly unlikely that the call will be opened up to those issues.  However, if that happens and any bills in this area pass, we’ll let you know in a future update.

Have a Good Summer!

Sunday, June 19^th, is the deadline for the Governor to veto pending bills, sign them, or allow them to become law without his signature.  If history is any guide, he’ll wait until the last day to sign most of this legislation.  We’ll post another revision after the signing deadline indicating which bills will become law, and which, if any, were vetoed.

While it’s theoretically possible that the Legislature could consider some of the bills that failed to pass during the current Special Session (officially, the “First Called Session”), it’s highly unlikely that the Governor would “open up the call” to those issues.  However, if he does, and any of them pass, we’ll include them in a future update also.

Happy Reading!

Earlier this year, we presented a TexasBarCLE webcast with Al Golden.  The paper we prepared for that webcast, entitled The Two-Year “Solution” – An Introduction to the Solutions Provided and Issues Raised by the Estate, Gift, and GST Tax Provisions of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, used the earlier translation as a starting point.  It has subsequently been used by a number of other presenters at many other seminars.

So, due to the “popularity” of The Two-Year “Solution”, we’re providing you a copy here.

As you may recall, some of the estate, gift, and generation-skipping highlights of TRUIRJCA include:

• Restoration of the estate tax for 2010 deaths with a $5 million tax-free amount and a 35% tax rate.
• “Elect-in” option for those estates where the current estate-tax free system is more beneficial (e.g., the George Steinbrenner estate, discussed here).
• “Reunification” of the estate and gift tax, meaning there will be an increase in the tax-free amount for lifetime gifts from $1 million to $5 million beginning in 2011.
• Indexing the $5 million tax-free amount for inflation after 2011.
• “Portability” of a deceased spouse’s unused tax-free amount to the surviving spouse beginning in 2011.
• Reinstatement of the application of the generation-skipping transfer tax rules to 2010 transfers – except that there will still be no GST tax on 2010 generation-skipping transfers.

The extended paper’s title is a reference to the fact that all of these provisions, and all of the other estate and gift tax provisions contained in the 2001 Bush tax cut bill, are extended by TRUIRJCA for only two years.

Friday, March 11^th, is the deadline for filing most bills.  That means we’ll have a pretty good idea by then what’s on the legislature’s plate.  New legislation can still be “introduced” through amendments of existing bills, but usually all of the “new” ideas have been filed by then.

Feel free to bookmark the location of the update.  We’ll be posting updates to the same location every week or so, even if there isn’t a new blog entry.

Since then, on Tuesday, December 14^th, the Senate passed the legislation.  On Thursday, December 16^th, the House passed the legislation – without amendment, but not after some significant legislative arm-twisting.  On Friday, December 17^th, President Obama signed the bill into law (using 11 pens – one for each letter in his name).

TRUIRJCA Highlights

The bill is called the “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.”  The estate, gift, and generation-skipping highlights of TRUIRJCA include:

• Restoration of the estate tax for 2010 deaths with a $5 million tax-free amount and a 35% tax rate.
• “Elect-in” option for those estates where the current estate-tax free system is more beneficial (e.g., the George Steinbrenner estate, discussed here).
• “Reunification” of the estate and gift tax, meaning there will be an increase in the tax-free amount for lifetime gifts from $1 million to $5 million beginning in 2011.
• Indexing the $5 million tax-free amount for inflation after 2011.
• “Portability” of a deceased spouse’s unused tax-free amount to the surviving spouse beginning in 2011.
• Reinstatement of the application of the generation-skipping transfer tax rules to 2010 transfers – except that there will still be no GST tax on 2010 generation-skipping transfers.

But, as we told you before, all of these provisions, and all of the other estate and gift tax provisions contained in the 2001 Bush tax cut bill, are only extended for two years.  Thus, we’re likely to see a reprise of these same arguments at the end of 2012, in the lame duck session that follows the 2012 elections.

Updated Lagniappe

In our December 13^thpost, we provided a link to a preliminary “translation” of the TRUIRJCA provisions into language more easily understood by tax professionals.  We have updated that translation to include the actual dates that are keyed to the date of enactment – December 17^th.  Practitioners can find that updated translation here.

In the last couple of weeks, the estate tax has gone from being a step-child in the Bush tax cut extension negotiations to being the poster child for what some consider the excesses of the so-called Obama-GOP compromise.

So in order to bring you up to date on the current state of the estate tax negotiations, a little history is in order.  Let’s go all the way back to December 2^nd.  Of this month.

The Baucus Bill

Sen. Max Baucus (D-MT), chairman of the Senate Finance Committee, introduced a bill on December 2^nd that contained his proposed estate tax compromise.  The tax-free amount for estate tax purposes would be permanently set at $3.5 million, and the maximum rate would be 45%.  This was the state of the estate tax law in 2009.  The bill also contained generous deferrals of estate taxes on agricultural land.  The main downside to practitioners was the effective date language.  Many of our clients were waiting until year-end to make large taxable gifts in order to take advantage of this year’s 35% rate on gift taxes (discussed here).  The Baucus bill raised the rate back to 45% effective the date of introduction – December 2^nd.

Two days later, on Saturday, December 4^th, the Baucus bill fell seven votes shy of reaching the necessary 60 votes to break a filibuster in the Senate.  So much for that solution.

The Obama-GOP Compromise

Two more days, and on Monday, December 6^th, President Obama and the GOP leadership in Congress announced that they had reached a compromise on the Bush tax cut extension.  The outlines of the estate tax portion were a $5 million tax-free amount and a 35% tax rate.  Far more generous than any year of the Bush tax cut, excluding this year when there are no estate taxes.  But we estate planners were waiting for more details.  No actual language was provided at the time.

House Democratic Caucus Rejects Obama-GOP Compromise

Three days after that, on the morning of Thursday, December 9^th, the House Democratic Caucus met, and by what has been reported as a virtually unanimous voice vote, rejected the Obama-GOP compromise.  Their ire was aimed at extending the Bush tax cuts for those making more than $250,000.  And at what they considered to be overly-generous estate tax provisions.  Our local Representative, Lloyd Doggett (D-TX), stated their position succinctly: “If it's take it or leave it, we'll leave it.”

But the caucus vote was not binding on anyone.

The Senate Amendment to House Amendment to Senate Amendment

Later that evening, the Senate Amendment to House Amendment to Senate Amendment to H.R. 4853 was released.  This bill is co-sponsored by Senate Majority Leader Harry Reid (D-NV) and Senate Minority Leader Mitch McConnell (R-KY).  This bill contains the text of the legislation enacting the Obama-GOP Compromise.  The “short title” of the bill is the “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.”  Let’s just shorten that to TRUIRJCA.

TRUIRJCA Highlights

The estate, gift, and generation-skipping highlights of TRUIRJCA include:

• Restoration of the estate tax for 2010 deaths with a $5 million tax-free amount and a 35% tax rate.
• “Elect-in” option for those estates where the current estate-tax free system is more beneficial (e.g., the George Steinbrenner estate, discussed here).
• “Reunification” of the estate and gift tax, meaning there will be an increase in the tax-free amount for lifetime gifts from $1 million to $5 million beginning in 2011.
• Indexing the $5 million tax-free amount for inflation after 2011.
• “Portability” of a deceased spouse’s unused tax-free amount to the surviving spouse beginning in 2011.
• Reinstatement of the application of the generation-skipping transfer tax rules to 2010 transfers – except that there will still be no GST tax on 2010 generation-skipping transfers.

But, the catch is that all of these provisions, and all of the other estate and gift tax provisions contained in the 2001 Bush tax cut bill, are only extended for two years.  Thus, we’re likely to see a reprise of these same arguments at the end of 2012, in the lame duck session that follows the 2012 elections.

Predictions?

This blog entry is being posted the morning of December 13^th.  TRUIRJCA is scheduled for a Senate vote later today, and is expected to pass “with ease.”  But, as noted at the beginning of this post, for many, these estate tax provisions remain a serious impediment.  According to the Washington Post:

For Democrats in both chambers, the most onerous provision in the package would exempt estates valued at up to $10 million from a newly imposed estate tax. … “Most of us agree with almost all of what the president negotiated,” Rep. Chris Van Hollen (D-MD) told Fox News Sunday"  "There is one thing that just was the choking point, and that deals with the estate tax break.”

I make no predictions as to what will ultimately happen.  My guess is that something will pass before this Congress adjourns, and the structure of what passes will be similar to the provisions of TRUIRJCA.  The numbers may change, but I don’t think the overall analysis will.

Some Lagniappe for Practitioners

As practitioners know, the devil is in the details – in this case, the exact statutory language.  For example, it’s taken ten years for many to understand that EGTRRA’s one-year repeal of the GST tax in 2010 did not mean that 2010 transfers were forever exempt from GST taxes.  TRUIRJCA changes this.  Whereas EGTRRA made the entire GST transfer tax system inapplicable for 2010 transfers, TRUIRJCA takes the opposite approach, and makes the entire GST transfer tax system applicable, but without any tax on 2010 GST transfers.

Since I’m betting that while particular numbers may change, something very similar to the current version of TRUIRJCA will ultimately pass, I’ve prepared a preliminary “translation” of the TRUIRJCA provisions into language more easily understood by tax professionals.  That document can be found here.  A word of caution, however.  This translation is not designed to be particularly user-friendly for laypersons.  It’s designed for someone who already has a fairly healthy working knowledge of the current transfer tax system.

The “Unified” Estate and Gift Tax System

In 1976, Congress instituted a “unified” estate and gift tax system.  Taxable gifts during lifetime and estates at death were subject to the same tax rates, and the same tax-free amount.  If you used a portion of your tax-free amount on large gifts during your lifetime, that reduced the tax-free amount remaining available to your estate at your death.  It wasn’t until the 2001 tax act (discussed here), that the tax-free amount for estate tax purposes began to exceed the tax-free amount for gift tax purposes.  But the concept of lifetime taxable gifts reducing the tax-free amount available for estate tax purposes remained.

Advantages of Large Lifetime Gifts

So why make gifts during lifetime if they’re going to be taxed anyway at death?  Well, there are several advantages to large lifetime gifts.  First, if you give away an appreciating asset, the amount taxed is its value on the date of the gift.  If the asset continues to appreciate until the date of your death (hopefully many years later), you’ve essentially gotten all of that future appreciation, not to mention any income generated by the asset following the gift, out of your estate tax-free.

Second, even though the two systems were “unified,” they really aren’t the same.  Gift taxes are calculated on a tax-exclusive basis, meaning the amount that’s taxed is the amount the donee receives.  Estate taxes are calculated on a tax-inclusive basis, meaning the amount that’s taxed is the amount in your estate, including the portion used to pay estate taxes.  Here’s an example to help you understand the difference:

Assume you’ve got $1 million available to give away in the most tax-effective manner (i.e., you want to get the most after-tax dollars in the recipient’s hands).  Assume also that you’ve used up all of your tax-free amounts, and that the gift or estate tax rate is 50%.  If you die with that pot of money going to the beneficiary subject to estate taxes, the tax burden will be 50% of $1 million, or $500,000.  The beneficiary will receive the remaining $500,000.  On the other hand, if you choose to give that pot of money away during your lifetime, you can give the beneficiary $666,666, not just $500,000.  The gift taxes will be 50% of $666,666, or $333,333.  All covered by the $1 million you started with (I’ll take the dollar that’s left over for giving you the idea).

Okay, one more benefit to large lifetime gifts, related to the tax-exclusive nature of the calculation.  When you die, your estate will be $1 million less, because you’ve either that money to the beneficiary, or paid it to the IRS in gift taxes.  In other words, it’s not your money anymore.  Of course, the government has thought of this.  You can’t make large lifetime gifts on your death bed, hoping to tax advantage of the more favorable gift tax calculation.  If you die within three years of making a taxable gift, the gift taxes you paid on that gift will be taxed in your estate as if you still had that money in your pocket.

Additional Benefits of 2010 Gifts

While the 2001 tax act eventually led to differing tax-free amounts for estate and gift tax purposes (last year, the estate tax-free amount was $3.5 million, but the gift tax-free amount remained at $1 million), the tax rates applicable to taxable transfers remained the same, although both decreased during the past 10 years from a maximum rate of 55% to 45% in 2009.  As you already know (because you’re a diligent follower of all of our blog posts), there is no estate tax this year.  But the gift tax remains in place, primarily to discourage income-shifting by transferring assets to recipients in lower brackets, then transferring the receipts back to the original donor.  However, the one concession on the gift-tax front this year is that (if you act now!) the maximum rate of tax on large taxable gifts this year is only 35%.  So going back to the $1 million pot of money, this year you could give away $740,740, and pay only 35% of that amount, or $259,259, in gift taxes (again, pay us the leftover dollar for giving you the idea).

But wait, there’s more!  Normally, we have an additional generation-skipping transfer tax imposed on gifts to beneficiaries who are more than one generation below the donor (e.g., gifts to grandchildren).  But like the estate tax, the “GST” tax has taken a one-year hiatus.  So if you make a large gift to your grandchildren, you not only take advantage of the lower gift tax rate, you also get to avoid the GST tax completely.  (Note that this benefit only appears to work for outright gifts to grandchildren, and not gifts to trusts for grandchildren – or even custodianships for them if they’re minors).

Not So Fast, My Friends!

Remember, the tax-free amount for both estate and gift tax purposes is scheduled to return to $1 million next year, with a marginal tax rate back up to 55%.  Even if Congress passes some tax relief, we’re unlikely to see anything larger than a $5 million tax-free amount for estate tax purposes or a marginal rate lower than 35%.  So if you’ve got a very large estate, why wouldn’t you rush out to take advantage of this limited-time offer?

Well, let’s say Grandmom reads our blog, calls her friendly estate planning attorney, and on his advice, gives away that $740,740 to her grandchildren for Halloween instead of giving them candy.  But then she dies in a tragic car accident over the Thanksgiving holiday (sorry to be so morbid, but stay with me here).  Next April 15^th, the still-friendly estate planning attorney reminds Executor to pay the IRS the $259,259 owed in gift taxes on the taxable gift.  Imagine this exchange:

Executor:       ”But I thought there would be no estate taxes since Grandmom died in 2010?”

Attorney:       “That’s right, Executor.  But this money isn’t for estate taxes, it’s for gift taxes.”

Executor:       ”But I thought the whole reason for her gift was to save taxes?”

Attorney:       “That’s right, Executor.  But we assumed that Grandmom wouldn’t die until after the end of 2010, when the estate tax returned and we’d owe estate taxes.”

Executor:       ”So we don’t owe estate taxes, but we owe gift taxes.  How much would we have owed if Grandmom had planned on giving us $740,740 for Christmas,instead of Halloween, but died before making the gift?”

Attorney:       “Well, since there are no estate taxes for persons dying in 2010, you wouldn’t owe anything.”

Executor:       ”So remind me again why we didn’t wait to see if Grandmom was going to live the rest of the year?”

Attorney:       “Well, she was so excited about the tax-benefits of the gift, she wanted to get it over with.”

Executor:       ”Did you mention to her it might have been better to wait until later in the year?”

Attorney:       “Well, no.  You know, Executor, you sure do ask a lot of question!”

You get the drift.  This may be a great idea, but since the whole point is to save taxes, and none of those taxes will be owed if the donor dies this year, there’s actually a good reason to procrastinate until the last week of the year.

As complicated as all of this may sound, it’s actually probably a bit more complicated.  But if you happen to be one of the lucky ones with a large enough estate to benefit from these techniques, the time to talk to your estate planning lawyer is right now, if not yesterday, so that everything can be put in place to make sure the gift can be made at the end of the year.

And we sincerely hope that you’ll be there to celebrate a Happy New Year!

Because we’re so early in the process, at the current time the legislative preview only contains a description of the legislative package that REPTL will be supporting.  Once prefiling of legislation begins (the Monday after the November elections), we expect to update the preview frequently, so check back for more details then.

Highlights of REPTL’s 2011 legislative package include:

• Optional “one-step” procedure for executing wills and self-proving affidavits.
• Clarification of procedures to be followed (or not followed) in independent administrations.
• Changing the standard compensation of executors, administrators, and guardians from the current system based on 5% of receipts and 5% of disbursements to a “reasonable compensation” system.
• Allowing affidavits to be filed in lieu of inventories if all debts have been paid by the time the inventory is due (a sworn inventory must still be provided to beneficiaries).
• Supporting the Texas Legislative Council’s recodification of the guardianship portions of the Probate Code (effective January 1, 2014).
• Replacing our current power of attorney act with an updated act based on the 2006 uniform act.

There will be many more proposals that are introduced during the session, and we won’t know which ones will ultimately pass and be enacted into law until next June, but we’ll keep you up to date as best we can.

The Fundamentals of Basis

One of the most valuable tax breaks (perhaps the only one) available when someone dies is the “step up” in basis of virtually all of their assets.  Prior to this year, when we had a federal estate tax, Section 1014 of the Internal Revenue Code provided that, with limited exceptions, property acquired from a decedent (that was subject to estate taxes – even if none were due) would receive a new basis in the hands of the beneficiary equal to the value of the property on the date of death.  This meant that no one would ever have to pay income taxes on the built-in appreciation of the decedent’s assets prior to the decedent’s death.  This was known as a “step-up” in basis, although a more accurate term would be “new basis at death,” since it was possible for basis to go down, not just up.  We lucky residents of community property states received a double benefit.  In the case of community property, both the decedent’s half and the survivor’s half of the community estate received this step-up in basis.  To put it another way, if one spouse died while this rule was in effect and all of the property was community property, the surviving spouse could sell virtually any asset and only pay capital gains tax on the appreciation of that asset following the first spouse’s death.

Carryover Basis

However, the 2001 tax act repealed this provision for persons dying after 2009.  It was replaced by new Section 1022, enacted in 2001 but only applicable to the estates of persons dying after 2009.  This provision enacted a general “carryover basis” rule, meaning that the beneficiaries would receive the same basis in assets that the decedent had, and there would be no magical disappearance of capital gains tax.  This is essentially the same rule that has always applied to the basis of gifts made during lifetime.  (After this year, when the estate tax is back in effect, Section 1014 goes back into effect, and Section 1022 goes away.)

However, Section 1022 contains a couple of basis adjustments that could be helpful in most estates.  First, the basis in a decedent’s assets can be increased by a total of $1.3 million (although the basis in any particular asset may not be increased above its fair market value on the date of death).  Second, there is an additional $3 million basis increase available for assets passing to a surviving spouse in a qualifying manner (essentially, passing to the survivor outright or in a special trust that would have qualified for the estate tax marital deduction commonly known as a “QTIP” trust).  And like the step-up in basis available for the surviving spouse’s half of the community estate, both of these basis adjustments are available to be allocated to the survivor’s half of a community estate.  Remember, these adjustments cover up to $4.3 million in gain, not just the value of assets, so for many estates much larger than $4.3 million at the first spouse’s death, there would be a full step-up in basis.

Mechanics of Basis Allocation

If someone dies this year, how do you document the allocation of your basis adjustments?  That’s a good question.  The Internal Revenue Code provides some answers, but not all of them.  Here’s what we do know.

• Code Section 1022(d)(3)(A) provides that the executor of an estate is supposed to allocate the adjustments on the return required by Code Section 6018.
• Code Section 6018 provides for “Returns Relating to Large Transfers at Death” as the replacement for the former federal estate tax return.  The return is required if the value of all of the decedent’s property (other than cash) exceeds the amount of the $1.3 million basis adjustment available to everyone.  The return is to include the following information:
• The name and tax identification number of each recipient of property;
• an accurate description of the property;
• the adjusted basis of the property in the hands of the decedent and the fair market value of the property at the time of the decedent’s death;
• the decedent’s “holding period” (i.e., how long the decedent owned the property – for long- vs. short-term capital gains purposes);
• any information necessary to determine whether any sales proceeds would be treated as ordinary income;
• the amount of basis increase allocated to the property; and
• any other information required by the IRS.

It may come as no surprise that the IRS has yet to publish this form.  One of the reasons for this is that under Code Section 6075, the large estate return is to be filed with the decedent’s last income tax return (i.e., next April 15^th, plus any extensions, at the earliest).

Was the “Repeal” of the Estate Tax Really a Tax Reduction for Most?

According to the nonpartisan Tax Policy Center, there were about 2.5 million deaths in 2009.  That year’s $3.5 million tax-free amount generated under 15,000 estate tax returns.  Only about 5,500 of those returns reported a taxable estate (i.e., almost 10,000 of the returns reported no federal estate tax due).

This year, of course, none of those deaths would generate a taxable estate for estate taxes.  However, some estimates indicate that the current carryover basis rules could affect at least 50,000 taxpayers.  So it appears that the “repeal” of the estate tax this year may have resulted in almost ten times as many taxpayers seeing an increase in their overall tax bills as saw a decrease.

The value of Mr. Steinbrenner’s estate is estimated to be worth about $1.5 billion.  We have no idea how accurate this estimate is, but let’s assume it’s accurate for the purposes of this illustration.  Assuming Mr. Steinbrenner had made no large taxable gifts during his lifetime, then the federal estate tax on an estate of that size for a person dying last year (2009 tax-free amount of $3.5 million and maximum 45% marginal rate) would have been almost $675 million.  Under current law, if he died next year (2011 tax-free amount of $1 million and maximum 55% marginal rate) with that estate, the total federal and state estate taxes would be about $825 million.  However, there is no federal estate tax due on the estates of persons dying this year, due to the one-year “repeal” included in the 2001 tax act described in our first installment.  The total tax-savings for Mr. Steinbrenner’s heirs doesn’t quite approach these amounts.  When you pay estate taxes, you also get a new basis in those assets equal to their value on the date of death.  This means that the estate or the beneficiaries can liquidate the assets and pay no capital gains tax on the built-in appreciation accumulated prior to death.  This year, however, when there is no estate tax, the assets retain the same basis that they had while the decedent was alive (with minor adjustments).  Therefore, when the assets are eventually sold, there will still be capital gains tax to pay on that built-in accumulated appreciation.  This reduces the total tax savings, but doesn’t come close to wiping out the savings.  (We can’t calculate the actual savings with more certainty without knowing Mr. Steinbrenner’s original basis in the assets.)  So dying this year may not have been good news for Mr. Steinbrenner, but it was at least a mixed blessing for his family.

More Timely Deaths of Billionaires

Mr. Steinbrenner is not even close to being the wealthiest person to “take advantage” of the 2010 tax-break.  He’s just the most well-known because of his colorful stint as the owner of the Yankees.  Other billionaires who have died this year, and their reported worth, include Walter H. Shorenstein, a California real estate developer ($1.1 billion); Dan L. Duncan, a Houston pipeline investor($9.8 billion); and Janet Morse Cargill, a member of the family that founded Cargill Inc. ($1.6 billion).  Together, the cumulative wealth of Mr. Steinbrenner and these other three billionaires could have generated almost $6.3 billion.  According to the Office of Management and Budget, estimated federal outlays for the 2010 fiscal year total $3.834 trillion.  The lost estate tax revenue from these four estates alone could have covered 0.1643% of the total year’s expenditures.  To put it another way, the lost revenue could have funded 14 hours and 24 minutes of federal operations.  Perhaps not too impressive, until you consider that this is just four estates, our federal deficit is about $1.267 trillion (the lost estate tax revenue from the four estates would have covered almost ½% of the deficit), and we’re only about halfway through the year.

A Tax-Planning Opportunity?

For persons with large estates, the tax-savings benefits of dying in 2010 are obvious.  However, for equally obvious reasons, there are certain non-tax disadvantages, especially for the prospective decedent.  Therefore, it is difficult to actively take advantage of this opportunity (although there have been plenty of discussions of the dilemma that may face families with loved ones on life support near the end of the year).  We’ll discuss more appropriate opportunities in future installments.

A Brief Look Back:

Under current law, there is no federal estate tax imposed on the estate of anyone who dies this year – no matter how large the estate.  Last year, we had an estate tax with a tax-free amount (the largest amount that can pass free of any estate tax, regardless of the amount of any deductions) of $3.5 million.  Next year, we are scheduled to have an estate tax once again, but with a significantly reduced tax-free amount of $1 million.  How did we get into this somewhat illogical situation?

To figure out where we are now, we need to go back about 35 years.  The Tax Reform Act of 1976 “unified” the estate and gift tax provisions, and increased the tax-free amount of $60,000 in stages so that by 1981, the tax-free amount exceeded $175,000.  Then, the Economic Recovery Tax Act of 1981 made two more significant changes to the estate tax laws.  First, the tax-free amount was increased again, so that by 1986 it reached $600,000.  Second, and perhaps more importantly, the 1981 tax act introduced the “unlimited marital deduction,” allowing married couples for the first time to assure that no estate taxes need be paid while either of them was alive.

In 1986, the Tax Reform Act of 1986 introduced a new transfer tax, the “generation-skipping transfer tax,” designed to discourage taxpayers from avoiding estate taxes in younger generations by making dispositions in ways that would not be subject to estate or gift taxes in those younger generations (a previous incarnation of the “GST tax” enacted 10 years earlier never went into effect).

The Taxpayer Protection Act of 1997 increased the tax-free amount once again in stages so that by 2006, the tax-free amount was scheduled to increase to $1 million.  However, in 2001, by which time the tax-free amount had increased to $675,000, the Economic Growth and Tax Relief Reconciliation Act of 2001 increased the tax-free amount to $1 million the following year (2002), and contained further increases to $3.5 million by 2009.  In addition, the highest marginal rate, which had been 55%, was decreased in stages so that by 2007, the highest rate was reduced to 45%.  And the topper was that no estate tax would be imposed on the estate of anyone dying after 2009!  Those in favor of this bill hailed the anticipated end to the dreaded death tax!  The gift tax still remains (mostly to prevent income tax avoidance), with a tax-free amount of $1 million for lifetime taxable gifts and a maximum marginal rate this year of 35%.  That’s where we are today.

The Catch:

But there’s a catch.  Almost all of us are familiar with the Senate rule requiring 60 votes to end a filibuster.  There was (and is) a similar Senate rule requiring 60 votes to pass any tax reduction having an effect lasting more than 10 years.  The 2001 tax act had enough votes to pass, but not enough votes to satisfy this permanency rule.  Therefore, the 2001 tax act (which included many other well-known tax breaks, such as the 15% capital gains rate and favorable taxation of dividends) included a “self-destruct” clause, providing that all of the changes contained in the act would expire at the end of 2010, leaving us in the same position as if the 2001 act had never passed.

The Current Status of the Estate Tax:

So where will we be next year?  If all of the provisions of the 2001 tax act expire at the end of this year, we will be back where we were before its passage.  Remember, the 1997 tax act (which did receive sufficient votes to satisfy the permanency rules) would have increased the tax-free amount to $1 million by 2006.  Therefore, next year we’re scheduled to have a tax-free amount of $1 million for both estate and gift tax purposes.  And the GST tax (which also is on “hiatus” this year) will come back with a tax-free amount of about $1.35 million ($1 million, indexed for inflation following 1997).

If you think none of this makes any sense, we agree!  That’s why immediately following the passage of the 2001 act, virtually the entire estate planning profession confidently predicted that Congress would clean up this mess long before 2009 arrived.  But Congress had other things on its collective mind (or nothing at all, depending on your perspective).  As the end of 2009 approached, we remained confident that Congress would make some change, rather than allowing us to enter 2010 without any estate tax.  In fact, in December of 2009, the House passed a bill effectively freezing the estate tax at 2009 levels – a tax-free amount of $3.5 million and a tax rate of 45% for estates above that level.  But later that month, the Senate Finance Committee failed to pass the bill out for a floor vote.

More to Come:

In early 2010, there was still some anticipation that Congress might try to pass some type of estate tax bill that would take effect retroactively to the beginning of the year.  No estate tax bill came even close to receiving any significant action.  None appears imminent.

In coming installments, we’ll discuss some of those estate tax proposals, planning opportunities – and pitfalls, and more.  Stay tuned…