Newsletter: May 2010
May 20, 2010
In this issue: Federal Estate Tax Planning In 2010; Planning With Family Limited Partnerships; Early Withdrawals From Retirement Accounts
FEDERAL ESTATE TAX PLANNING IN 2010
Are we getting closer to an estate tax answer for 2010?
As discussed previously in this newsletter, the federal estate tax has expired and carryover basis is currently in effect. Heirs can exclude up to $1.3 million of gain on future sales of inherited assets, plus $3 million more for sales by surviving spouses. Next year, heirs will be able to use the date-of-death value once again for inherited assets.
But in 2011, the federal estate tax is slated to return with a $1-million exemption and a maximum tax rate of 55%; a reinstitution that many lawmakers do not want to see come to pass. To this end, legislators in the House prefer reinstitution of the tax in 2011 with a $3.5 million exemption with a 45% maximum rate. In the Senate, however, there is growing support for raising the exemption to $5 million and imposing a top rate of 35%.
Right now, odds seem to favor a phased in version of the Senate plan calling for periodic increases in the exemption over time to increase it from $3.5 million to $5 million and lowering the top rate from 45% to 35%.
Do you know your clients’ asset basis?
Despite all of the talk with regard to a retroactive reinstitution of the federal estate tax in 2010, it is still seems likely that we will not, in fact, see such a change in the law. If lawmakers do not attempt to reinstitute the estate tax on a retroactive basis, or if estates are able to choose the tax repeal and carryover basis adjustment, a “Large Transfers at Death Return” is required to be filed if a decedent has assets with a fair market value in excess of $1.3 million (excluding cash) at the time of his passing.
The return is due to be filed with the decedent’s income tax return for his last taxable year. The executor, who is responsible for the filing of the return, must also report to the property recipient as well as the IRS. The purpose of the return is to report all property that has been acquired from a decedent and to allocate additional basis among the decedent’s assets.
For 2010, a person may obtain a basis adjustment for $3,000,000 of assets passing to a surviving spouse (the “spousal property basis increase”) and for an additional $1,300,000 of assets passing to the spouse or other beneficiary (the “aggregate basis increase”). The penalty for failure to file this return is somewhat severe, particularly for intentional disregard of the rules for reporting, which is 5% of the value of the property subject to the reporting requirement.
The Executor of an Estate may allocate an additional amount of $1.3 million of basis among a decedent’s assets passing to any person, on an asset-by-asset basis. The assets to which basis increase may be allocated are those that are both acquired from the decedent and owned by him on his date of death. The basis increase cannot exceed the fair market value of the asset on the date of death. The Executor of the Estate may also allocate an additional amount of basis increase of $3 million to property the surviving spouse acquires from the decedent. This basis increase is only allowed for property passing outright to the spouse or in a QTIP trust. Other types of trusts do not qualify for the basis adjustment.
Record keeping is critical to evidence the decedent’s adjusted basis in his assets so that accurate basis adjustments can be planned and allocated. You are a vital link in the chain! Please plan now for possible basis adjustment scenarios so that the client’s family is best prepared to make the necessary decisions.
As always, we will continue to do our best to keep you up-to-date concerning any emerging developments in these areas!
PLANNING WITH FAMILY LIMITED PARTNERSHIPS
Why clients may want to consider converting from an FLP to FLLC.
Family Limited Partnerships (“FLPs”) have been an important estate planning tool for many years, and we have established many FLPs for our clients. Family Limited Partnerships offer many benefits such as:
- Centralized management of family assets;
- Asset protection planning to protect family assets from creditors, lawsuit, divorce, etc;
- Keep assets in family bloodlines;
- Increase involvement of younger family members in financial affairs;
- Fractionalization of interests in an asset to facilitate gifting among family members;
- Potential discount on value of gifts between partners; and
- Potential discount on value of partner’s LP interest at death.
Due to the fact that FLPs can be so effective in reducing estate and gift tax liability, the IRS often challenges the valuations of FLP interests taken on estate and gift tax returns. Therefore, properly structuring and running a limited partnership is vitally important.
The FLP must have a legitimate and significant non-tax purpose for its existence, the partners must retain sufficient assets outside of the FLP to maintain their lifestyles, and the FLP must be run as a legitimate business with business formalities followed. For these reasons, we meet at least annually with our clients that have established FLPs so that all partners can be kept apprised of partnership activities and assets.
Presently, at these annual FLP meetings, we are discussing and often recommending that a family limited partnership be converted to a limited liability company (“LLC”). For clients who are just creating such a business entity, we most often recommend setting up a limited liability company rather that a limited partnership.
An FLP must have a general partner who has personal liability if the partnership should be sued. Only the limited partners have no personal liability in a partnership. In an LLC, none of the members has personal liability if the LLC is sued. Further, an LLC has the option for income tax purposes to be treated as a partnership or a corporation which allows for flexibility in income tax planning.
In Ohio, a limited partnership can be converted into a limited liability company with the filing of a couple of state forms and paying a small processing fee. The tax identification number used by the FLP can be used by the new LLC. An Operating Agreement for the LLC should be prepared and signed by all members. The Operating Agreement would replace the old Partnership Agreement and allows us to update the terms governing the business.
Just as we review and update the trusts that we create for our clients, how limited partnerships are managed and the written agreements that direct how the partnership is run should be reviewed periodically. Revisions to partnership agreements can be vital to maintaining and maximizing the personal and tax goals of the FLP.
EARLY WITHDRAWALS FROM RETIREMENT ACCOUNTS
Is it safe to assume that an individual receiving Social Security Disability can receive distributions from an IRA or qualified plan account without incurring the early withdrawal penalty of 10% under the disability exemption?
Under the Internal Revenue Code, an individual may receive distributions from an IRA or qualified account without incurring the 10% early withdrawal penalty so long as the individual is disabled. An individual is disabled if “he is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration”. Each component of this definition has been widely litigated and addressed in private letter rulings and case law. The issues have resulted in inconsistent outcomes and the factual circumstances have created subjective findings.
Often times the IRS has ruled that even though an individual was receiving Social Security disability benefits he or she did not meet a specific requirement of the disability definition under the Internal Revenue Code. As a result, the individual was penalized for receiving a distribution from his qualified account and charged with penalties and interest.
It is no longer safe to assume that your client will qualify for the disability exemption just because he or she is receiving Social Security disability benefits. You need to consult with your clients prior to requesting distributions under the disability exemption to discuss your client’s specific impairments and disabilities and to obtain documentation to support his or her position in the event the IRS decides to audit your client’s return.