ADMINISTERING “JOINT REVOCABLE TRUSTS” AFTER DEATH

Posted on March 28, 2012 by David C. Streicher

Most married couples using a revocable trust select what is commonly referred to as a “joint trust.” Instead of having to split or horse trade assets between each spouse’s separate trust, they are all pooled into a single trust. This makes the “funding” process light years easier. In many instances, clients would refuse to use a revocable trust if they had to split assets between two separate trusts. Closing existing cash and brokerage accounts, setting up new accounts and balancing future withdrawals between the accounts is just too much.

When the first spouse dies, however, we often have to perform the splitting, etc. that we avoided when the trust was originally established. Conceptually, most joint revocable trusts split into two shares, one for the decedent and one for the surviving spouse. The decedent’s share may be further divided into two shares, one known as the “credit shelter” or “bypass” trust, and the other known as the “marital trust.” The surviving spouse’s share is usually referred to as the “survivor’s trust.”

For liquid assets, most clients bite the bullet and set up new accounts after the first spouse dies. The “credit shelter trust” is a new taxpayer (with a new tax identification number) and only by setting up a new account will the income be referenced to the proper tax identification number. The surviving spouse frequently leaves her half in the historical accounts, but arranges for the bank or brokerage house to exclusively use her SSN for the account, and remove her husband’s SSN.

For real estate, there are alternatives. Before death, the real estate was owned by the joint trust, i.e., Robert Smith and Jane Smith, Trustees of the Robert and Jane Smith Revocable Trust dated 3/28/2012. After death, the property is conceptually owned 1/2 by the “credit shelter trust,” and 1/2 by the “survivor’s trust.”

One approach is to execute and record deeds memorializing the split. For example, the deed might convey the property to: Jane Smith, Successor Trustee of the Credit Shelter Trust established under the Robert and Jane Smith Revocable Trust dated 3/28/2012, as to an undivided 1/2 interest, and Jane Smith, Successor Trustee of the Survivor’s Trust established under the Robert and Jane Smith Revocable Trust dated 3/28/2012, as to an undivided 1/2 interest.

There is a second approach which may be simpler and less expensive. It is to leave title to the property intact, and enter into a simple agreement (signed by the trustees) memorializing how the real property is divided between the subtrusts. The funding agreement will not be recorded in the real estate records. If the property is sold down the road, the seller on the deed will be the joint trust (i.e., Jane Smith, Successor Trustee of the Robert and Jane Smith Revocable Trust dated 3/28/2012), but the proceeds will be allocated in accordance with the funding agreement. Along the same lines, the rental income and deductions will be allocated between the subtrusts as if deeds had been signed and recorded.

In summary, administering a joint trust upon the death of the first spouse to die can be a tedious and time-consuming process. At least for real estate, you should consider the simpler and less expensive approach of documenting the division of property with a funding agreement.

BUSINESS SALE AGREEMENTS

Posted on March 27, 2012 by David C. Streicher

The purchase or sale of a business is always more complicated than it appears. The value is often based on fickle attributes such as business relationships and goodwill, rather than real estate or readily marketable equipment. Considerations that should be covered by the business sale agreement include the following:

Asset Sale or Stock Sale. This is the key threshold decision. The simplest form of acquisition is a direct purchase of shares from the owners. However, the more popular structure is an asset sale. In general, a stock sale provides superior tax results to the seller. From a buyer’s perspective, an asset sale provides substantial tax advantages and also avoids exposure for most liabilities of the business. Buyer’s key tax advantage to purchasing assets is that the buyer will be able to claim future depreciation and amortization deductions on most of the purchase price. Conversely, the price paid for stock of a corporation is not deductible. Although beyond the scope of this article, a buyer may be able to use a Section 754 election to treat the purchase of an LLC interest as a purchase of the LLC’s assets, and thereby secure future tax deductions similar to those from an asset sale.

Due Dilligence, Warranties and Representations. Whether the sale is of stock or assets, the buyer should thoroughly investigate the past financial performance of the business, and the sale agreement should contain representations from the seller that the financial information furnished to the buyer is correct. There should also be representations about the ownership and condition of the business assets. For example, the seller should disclose if fixed assets are damaged or in need of repairs. Assurance should also be provided that software used by the business is covered by licenses and not pirated. Is the equipment owned or leased?

Dealing With Liabilities. If the structure is a stock sale, the agreement should list the key liabilities of the business so that the buyer knows exactly what debt is being assumed. Some liabilities may not appear on the balance sheet. For example, the buyer will not learn of potential claims by employees for back wages, employment discrimination, etc. unless the seller makes affirmative disclosures. The same is true for tax liabilities related to prior years. A stock sale agreement will contain representations to the effect that seller is not aware of any liabilities other than those disclosed in writing to the buyer, and that the price will be adjusted if additional liabilities surface after the closing.

Non Compete Agreement. In both asset sales and stock sales, the buyer will desire a non compete covenant from the seller. The idea is that goodwill (often attributable to the seller’s business relationships) is a key asset of the business, and will be damaged or diminished if the seller starts a competing business. In general, the non compete covenant should identify the prohibited activities, the geographic area of restriction (if applicable), and the time frame of the restriction. A ripple effect is that the price of a non compete covenant is taxable as ordinary income when received by the seller, and can be amortized over 15 years by the buyer. For this reason, a buyer purchasing stock usually wants to allocate as much of the price as possible to the non compete agreement.

Seller’s Post-Closing Consulting Services. It is also common for buyer to retain the services of seller for one or more months after the closing to provide hands-on knowledge of the business and to transition business relationships to the buyer. For example, the seller might agree to work full-time for one month at a given salary, and then provide consulting services as needed for an hourly rate.

Employees. In an asset sale agreement, the seller typically terminates all employees and the buyer hires some or all of them immediately after the closing. This frees the buyer from potential employment related liabilities. Agreements often condition buyer’s obligation to close the transaction on key individuals being employed on the date of closing.

Allocation of Price. Allocation of the price is a key negotiating issue in an asset sale. Allocations to goodwill and non compete agreements can be deducted over 15 years by the buyer under Section 197 of the Code. However, allocations to equipment, inventory and accounts receivable can be deducted much more quickly. Goodwill is taxed to the seller as capital gain, while gain related to equipment, inventory and accounts receivable is taxed as ordinary income. For these reasons, a buyer will desire generous allocations to fixed assets and inventory, while a seller will favor allocations to goodwill.

Accounts Receivable. Accounts receivable are often excluded from an asset sale, primarily because collectability is usually speculative. Instead, it is common for the buyer to collect and remit the receivables on behalf of the seller and withhold a percentage to cover collection costs. There is usually a cutoff date when no further collection efforts are required of the buyer.

Payment Terms and Security. If the buyer is unable to pay the entire price at closing, which is usually the case, care should be taken to secure payment of the deferred balance. In general, the shares or assets being purchased will be used as collateral to secure the purchase price. Further, if the buyer is an entity, the seller will always require the owners of buyer to give a personal guaranty. The shares or business assets are of questionable value as collateral. Used equipment has only nominal value, and goodwill can quickly evaporate. For example, if the buyer mismanages the business or secretly sells the assets, the seller may be left with remedies of nominal value. There should always be a “due on sale” clause that accelerates the remaining balance of the price if the buyer sells the business or its assets.

Leases. In an asset sale, care should be taken to ensure all leases are assigned to buyer. It is not usual for the lessor to charge a transfer fee (of roughly $1,000 to $2,000) as a condition to consenting to the transfer. Responsibility for this fee should be negotiated by the parties. Security deposits are usually credited to the seller.

Prorates of Expenses. Ongoing expenses are commonly prorated based on the closing date. Rent and equipment lease payments are perhaps the most common pro rates. Smaller items such as utilities are frequently ignored. If the business has inventory, there is normally a price adjustment based on the inventory on hand on the date of closing.

Business Names; Telephone Numbers. If the parties use an asset sale structure, the transfer of business names should be memorialized by assumed business name filings with the Oregon Secretary of State. Responsibility for filing fees should be negotiated. Seller should agree to transfer all telephone numbers, domain names, websites and email addresses to buyer.

Broker Fees. Sellers commonly use a business broker to find a buyer. The commission ranges from 10% to 20%, and is payable in full at closing. It frequently consumes substantially all of the down payment, leaving seller with only the hope of receiving payments in the future. The broker’s commission is not affected by seller’s inability to collect future installments, which may invite a broker’s indifference about whether the buyer has the wherewithal and experience to successfully run the business and pay the seller in full. In practice, many of the potential buyers identified by the broker will present an unacceptable risk to the seller. The seller should be wary of assets on the buyer’s net worth statement that are beyond the reach of creditors. For example, assets such as the buyer’s residence (which may have no equity) and IRA (which is exempt from creditor claims) are all but irrelevant to the seller.

Earn Out. Parties occasionally adjust the price to take into account the post-closing performance of the business, which is frequently referred to as an “earn out.” This protects the buyer from the risk that key customers will leave, and motivates the seller to make a smooth transition. The earn out is usually a percentage of sales or profits in excess of an agreed benchmark. The duration of the earn out is usually just a couple of years.

This list is far from exclusive. In my experience, parties represented by a lawyer end up with a far better deal, and the related savings usually dwarf the legal fees. Do-it-yourself sellers frequently don’t get paid, and do-it-yourself buyers frequently end up with unanticipated tax consequences, business liabilities or misrepresented assets.

WHAT DOES A WILL COST?

Posted on March 20, 2012 by David C. Streicher

It is entirely reasonable and prudent to ask what a legal project will cost prior to authorizing work to begin. When it comes to estate planning, the more difficult issue is identifying what work you want performed. The following considerations should be taken into account.

Value of Legal Services ≠ Number of Pages. Clients occasionally look to the depth of the stack of papers to determine the value of the work performed. In reality, the number of pages has little to do with value conferred.

Is a Will All You Need? Most clients need more than just a will. Almost all of them also need fine-tuned beneficiary designations, advance directives for health care and durable powers of attorney.

Analysis in Designing Optimum Plan. Analysis is to an attorney what diagnosis is to a doctor. If you don’t meet with your attorney (in person or in a comprehensive phone call) to discuss and analyze your circumstances, you will probably end up with documents that don’t fit properly or are incomplete. Rather than paper, you are buying his knowledge and experience. For example, your attorney should have knowledge of the following:

● the best choice for executor

● planning to eliminate or minimize estate taxes

● planning to minimize income tax

● optimum disposition of closely-held businesses

● whether a will can be challenged

● a beneficiary designation trumps a will

● a marriage or a divorce revokes a will

● optimum trusts (or custodial accounts) for minor children

You won’t have the benefit of this experience and advice using do-it-yourself forms. Even for a very “simple” plan, the meetings and analysis should take a minimum of one hour.

Cost of Preparing Will. After performing the analysis described above, the drafting may or may not be relatively easy. Provided the will is similar to a standard template, an experienced attorney should be able to draft the will in perhaps an hour. Keep in mind, however, that most wills are not entirely “standard,” since every family has slightly different circumstances. Additional time is needed if you desire provisions that are custom drafted especially for you. (Although the materials are cheaper, custom drafting is really no different than building cabinets to fit the particular dimensions of your kitchen or bathroom.)

Cost of Preparing Advance Directives and Powers of Attorney. Absent custom provisions, this is largely a word processing exercise warranting only a few minutes of attorney time.

Beneficiary Designations. For many clients, IRAs and 401(k)s are their most valuable assets. A little known fact is that the beneficiary designations for these assets “trump” the will. It not unusual for clients to designate a primary beneficiary (usually the spouse) but no secondary beneficiary (usually the children). This may cause the decedent’s “estate” to be the beneficiary, which unnecessarily accelerates the deferred income tax on these assets. If you have minor children, you should designate trusts for them as the beneficiary, to avoid the expensive complexity arising when benefits are payable to a minor. Beneficiary designations can be time-consuming because they must be individually downloaded from the IRA or 401(k) custodian and filled out. This can easily take one or two hours. But your plan has a glaring “gap” if you don’t complete this step.

Cover Letter Explaining Plan. Your attorney should provide you a letter that explains and describes your plan and how the various documents accomplish your objectives. This can be saved for reference when you review the documents every few years. Even using stock templates as a starting point, the letter to the client takes time, but is valuable.

Summary. If you just want your attorney to draft a will, with no meetings, analysis or supplementary documents, the cost should only be an hour or two of attorney time. But is that really what you want?

WHAT IS A “BUY SELL AGREEMENT?”

Posted on February 29, 2012 by David C. Streicher

This post identifies key issues to be considered when planning or reviewing a buy sell agreement.

The term “buy sell agreement” is catchall phrase that refers to agreements affecting transfers of shares or interests in closely held businesses. For corporations, the buy sell agreement is usually a separate document, and not part of an employment agreement, for example. In the context of an LLC or partnership, however, buy sell provisions and compensation (i.e., distributions and guaranteed payments) are usually covered in a single agreement, which is known as an “operating agreement” for LLCs or “partnership agreement” for partnerships. In this article, “shares” includes LLC interests, partnership interests and shares of corporate stock. References to “buy sell provisions” are to the paragraphs in a buy sell agreement, operating agreement or partnership agreement that regulate transfers of shares.

In general, buy sell provisions have two key objectives. First and foremost, they prevent owners from transferring shares to outsiders. Second, they provide avenues for disentangling owners upon the occurrence of divisive events.

Transfer Restrictions. Absent restrictions on transfers of shares, an owner might unexpectedly learn that his business partners include spouses, children or creditors of other owners, or even a business competitor. Such restrictions also prevent disgruntled owners from selling S corporation shares to an ineligible shareholder. Transfer restrictions usually treat prohibited transfers as a nullity, which avoids these disruptive or disastrous consequences.

Rights of First Refusal. It is common to include a provision that allows an owner to transfer shares to outsiders, provided the other owners or the entity are given the prior right to purchase the shares for the same price and on the same terms. Rights of first refusal are seldom exercised. Shares of closely held entities are difficult to sell at any price, since potential purchasers seldom have the right to liquidate the business, receive compensation or compel cash distributions. Further, potential purchasers are reluctant to perform due diligence and negotiate a price if it is likely the process will be a futile exercise. Thus, one might characterize a right of first refusal as an illusory opportunity to sell shares to outsiders.

Options Triggered by Certain Events. A myriad of options ripen upon the occurrence of events commonly known as “triggering events,” such as death, disability, termination of employment and involuntary transfers. A fundamental assumption is that a triggering event permanently changes the objectives of the affected owner. For example, the heirs of a deceased owner typically want cash, whereas the continuing owners want to continue the business without the financial drain of financing a buyout. The same is typically true upon disability or termination of employment. Buy sell provisions are intended to disentangle parties with differing objectives.

The remaining owners or the entity will typically have an option (“call option”) or a mandatory obligation to purchase the shares of the owner affected by the triggering event. Or, the affected owner may have the right (“put right”) to compel the other owners or the entity to purchase his shares.

Death. At a minimum, most buy sell provisions give the remaining owners or the entity a call option to purchase the shares of a deceased owner. Occasionally, the remaining owners or the entity have a mandatory obligation to purchase the decedent’s shares. Another alternative is to give the executor of the deceased owner a put option to compel the other owners or the entity to purchase the decedent’s shares. In general, buy sell provisions triggered by death are liberal in favor of the decedent. For example, minority interests are seldom discounted and the time frame for payment is shorter than for other triggering events.

It is common for the entity to purchase life insurance on key owners to provide funding for redemption of their shares at death. An alternative is a “cross purchase” in which each owner purchases life insurance on the other owner(s). (This is most common if there are only two owners.) Although beyond the scope of this article, a cross purchase may be preferable when the entity is a corporation, since the purchaser will receive a stepped up basis in the purchased shares. (Having said that, if an S corporation receives life insurance proceeds, the adjusted basis of its shares will be increased pro rata.) The life insurance transfer for value rules of IRC §101(a)(2) and the basis adjustment rules of IRC §754 and IRC §1368 should be carefully considered when choosing the most suitable options triggered by death.

Disability. Especially when an owner is actively working in the business (e.g., services, manufacturing or sales, as compared to holding rental properties), a permanent disability is often a triggering event. A disability is usually deemed a triggering event if it permanently prevents the owner from performing his regular duties on a full time basis. If the entity has a disability insurance policy on the owner, the triggering event is usually the same as the definition of disability in the policy, so as to coordinate the entity’s redemption obligations with the proceeds from the policy. More often than not, however, there is no disability insurance or its proceeds are inadequate to fund the redemption. Due to the financial hardship on the remaining owners, disability frequently triggers only a call option available to the remaining owners. Disability provisions are necessary but often problematic. The permanence or severity of the disability may be in dispute. There is also the issue of who makes the determination.

Termination of Employment. Termination of employment of an employee owner ignites acrimony and a need to disentangle like no other triggering event. The terminated owner-employee may use his access to financial records to harass the entity. And he will inevitably want cash, either for living expenses or to start a competing business. If the business is increasing in value, the remaining owners will be annoyed that their efforts (and perhaps dividends) are inuring to an inactive owner. Accordingly, it is common to give the entity or remaining owners a call option to purchase the terminated employee’s shares. Frequently, the agreement will allocate a portion of the price to a non compete agreement preventing the terminated owner from starting a competing business. Options may be harsher if the owner is terminated for “cause,” which usually captures conduct such as fraud, criminal acts, drug or alcohol abuse, etc. Buy sell provisions triggered by retirement or termination without cause tend to be more liberal toward the former employee-owner.

Involuntary Transfers. A transfer of shares may be involuntary, such as by reason of bankruptcy or divorce. Most buy sell agreements provide call options to the entity or remaining owners as a mechanism to prevent shares from falling into the hands of former spouses or creditors. As covered in more detail below, the price and terms are usually favorable to the purchasers.

Price. Except for disfavored triggering events such as termination of employment for cause or involuntary transfers, the price is usually equal to a pro rata share of the value of the entity. In other words, there is no minority interest discount. Some agreements peg the price at an amount agreed to by the owners at the annual meeting preceding the triggering event. This is a very practical approach, except that meetings are frequently neglected and the value may be stale. For this reason, the agreed value is usually discarded if it more than one or two years old. As a backup, the value may be based on a formula. For example, an active business might be valued using a multiple of annual sales or cash flow. The final alternative is to determine the value of the entity by appraisal. Appraisals can be expensive, so the drafter should specify who bears the cost. If the triggering event is an involuntary transfer or termination for cause, it is common to apply a discount to the price or get to the same result by valuing the actual block of shares using the “willing buyer willing seller” approach.

Terms. If the triggering event is death, a portion of the price equal to any life insurance proceeds is usually payable in cash, either by the entity or the remaining owners, depending on whether the structure is an entity purchase or cross purchase. For other triggering events, the price is usually payable over a term ranging from 5 to 15 years and a down payment of 10% or 20% of the price. The term will tend to be longer and the interest rate will tend to be lower in the case of a disfavored triggering event. Occasionally, and especially for real estate holding companies, the deferred balance of the purchase price may be secured by a mortgage.

Summary. Buy sell provisions are analogous to a prenuptial agreement. A structure for disentangling is agreed to in advance, which reduces the fears and uncertainties otherwise associated with a triggering event. Buy sell provisions can be relatively simple or overwhelmingly complex, depending on the number of triggering events and the differences in options, prices and terms for each event. A buy sell agreement should be in place before it is “needed.” Ideally, this is at the commencement of the business. That may not be practicable, however, if the parties have limited funds and the business has nominal value. As the value of the business increases, and the parties get older, the value of a buy sell agreement is more evident. But it also more likely that circumstances of certain owners will have changed or a triggering event is imminent. In all events, if a practitioner can distill the buy sell provisions to a few key objectives, the process of getting an agreement in place will be manageable.

PROBATE PROCESS IN OREGON AND WASHINGTON

Posted on February 24, 2012 by David C. Streicher

Here is a general overview of the probate process for Oregon. Washington has some similarities but is substantially abbreviated, as noted below.

Probate requires the appointment of a personal representative (referred to as the executor in certain states). If the decedent dies testate, the personal representative ultimately appointed is usually the first nominee named in the decedent’s will. If the decedent dies intestate, the personal representative is usually the relative or friend who wins the race to the courthouse and files first.

For testate estates (i.e., the decedent died with a will), the will is proved and admitted by the court. Proof is usually through an affidavit of attesting witnesses to the will. See ORS 113.055(1).

Within 30 days of the appointment of the personal representative, the heirs, devisees, and persons described in ORS 113.035(8) and (9) are notified of the decedent’s death and the pending probate administration.

The personal representative identifies and values the assets of the estate and, within 60 days of appointment, files an inventory with the court. ORS 113.165. This is not required in Washington if the personal representative requests “nonintervention” powers, which is the typical approach.

The personal representative must make a reasonably diligent search for creditors of the estate and provide them notice of the probate proceeding. ORS 115.003. Unidentified creditors are notified by publishing notice of the personal representative’s appointment once per week for three weeks in a local newspaper of general circulation. ORS 113.155(1).

Each creditor must file a claim against the estate for debts owed by the decedent no later than 30 days after personal notice is mailed or four months after the newspaper notice is published, whichever occurs later. ORS 115.005(2). If the claim is not filed within the applicable period, the underlying debt is either subordinated to timely filed claims or barred. ORS 115.005(3). A different procedure applies to mortgage loans and other secured debt.

As appropriate, the personal representative liquidates the decedent’s property and pays allowed claims and expenses of administration.

The personal representative files any required state or federal income and death tax returns and pays any taxes due. See ORS 114.305(17).

After completion of the foregoing steps, the personal representative files a final account with the court. ORS 116.083(3). In Washington, the personal representative files a very short document known as ”declaration of completion” in lieu of a final account.

After court approval of the final account, the assets of the estate are distributed to the beneficiaries under the will or the heirs at law. ORS 116.113. In Washington, court approval is unnecessary to make the final distribution (or interim distributions).

Caveat: Probate is deceptively complicated. While generic probate filings can be routine, there are ample opportunities for malpractice. If claims are not disallowed within 60 days, they are deemed allowed. ORS 115.135(1). Death taxes must be paid within nine months after death or there will be substantial penalties (usually 5% per month). See, e.g., ORS 118.260(4); IRC §6651(a)(1).

Death taxes may have to be apportioned among various classes of beneficiaries. It may be necessary to select fiscal taxable years so that excess deductions are transferred to the beneficiaries under IRC §642(h), and not lost. It may be necessary to fund tax planning trusts based on a formula clause in the will. Although not technically part of the probate, tax guidance on distributions from IRAs is often necessary. This list could go on for pages.

Supervision by an experienced probate lawyer with a tax background is recommended.

REMINDER: “FATCA” FORM 8938 DUE WITH YOUR 2011 INCOME TAX RETURN

Posted on February 17, 2012 by David C. Streicher

If you are a US citizen or resident and own liquid assets in a foreign country (including Canada), you may be required to file Form 8938, Statement of Specified Foreign Financial Assets along with your 2011 US income tax return, i.e., Form 1040, 1041, 1120, 1065, etc., depending on whether the return is for an individual, trust or estate, corporation or LLC, respectively.

In general, Form 8938 requires disclosure of “foreign financial assets,” which generally means accounts holding cash or securities maintained by a foreign bank or brokerage house. However, the instructions indicate that interests in foreign mutual funds, foreign hedge funds, foreign private equity funds, foreign corporations, foreign partnerships and foreign trusts/estates are also included. Foreign real estate is not.

Offshore assets reported on Form 3520 (foreign trusts and gifts) or 5471 (foreign corporations) need not be reported on Form 8938 (although it must be noted on Form 8938 that Forms 3520 or 5471 have been filed to report these items). However, you must include on Form 8938 all items already reported on Treasury Form 90-22.1.

Filing Threshold – Single taxpayers living in the US must file Form 8938 if foreign financial assets exceed $50,000 at year end or $100,000 at any time during the year. These threshold amounts are doubled for married taxpayers living in the US and filing a joint return. If living abroad, the threshold for single taxpayers is $200,000 / $400,000, and the threshold for married taxpayers filing a joint return is $400,000 / $600,000.

Penalty – The penalty for failure to file Form 8938 is $10,000 per year.

2011 FBAR Form TDF 90-22.1 DUE JUNE 30, 2012

Posted on February 17, 2012 by David C. Streicher

If you are a US citizen or resident and have “offshore” bank or investment accounts (including accounts in Canada), read this:

Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (the “FBAR”), is used to report a financial interest in or signature authority over a foreign financial account. Your 2011 FBAR must be received by the Department of the Treasury on or before June 30, 2012. The June 30 deadline may not be extended.

HOW TO WITHDRAW A DECEDENT’S BANK ACCOUNT WITHOUT PROBATE

Posted on February 9, 2012 by David C. Streicher

In general, a probate is needed to transfer a decedent’s bank account if there is no joint ownership or POD designation. But not always.

In Oregon, a bank may disburse a deceased depositor’s account of $25,000 or less if the claimant furnishes the affidavit prescribed in ORS 708A.430(2). This procedure is available only if the decedent’s aggregate deposits in all Oregon financial institutions (e.g., banks and credit unions) do not exceed $25,000. The deposit is payable in the following order of priority: the surviving spouse, the Department of Human Services (if it has filed a claim), the surviving children who are age 18 or older, the surviving parents, or the surviving brothers and sisters who are age 18 or older. ORS 708A.430(1). Except when the claimant is the surviving spouse, the bank must wait 75 days after the date of death before disbursing the deposit, unless the bank first confirms that neither the Oregon Health Authority nor the Department of Human Services has a claim. ORS 708A.430(1). In the affidavit, the claimant must promise to pay all of the decedent’s debts (including medical and funeral costs) up to the amount of the deposit, and disburse the remaining money to the persons entitled under Oregon law.

If a probate is later commenced, the claimant must account for the deposit to the executor of the probate estate. ORS 708A.430(5).

PROBATE PROPERTY vs. NONPROBATE PROPERTY

Posted on February 9, 2012 by David C. Streicher

What is probate property? A nutshell description follows.

Broadly speaking, probate property is any asset for which title or ownership does not automatically transfer by survivorship, beneficiary designation, contract, or by operation of law at a decedent’s death. The type of property – tangible or intangible, personalty or realty – is not relevant. Instead, focus is on the form of ownership.

Ownership or title is usually evident from monthly statements (for bank or brokerage accounts) or commonly used documents, such as deeds for real property, certificates for stocks and bonds, and certificates of title for vehicles. Such documentation may be more unique for items such as patents, mineral and royalty interests, or interests in sole proprietorships and informal partnerships. Finally, most tangible personal property (e.g., personal effects, household furnishings, and currency) has no formal ownership documentation, which can be problematic in a second marriage or contentious family situation.

In general, nonprobate property is property that automatically transfers at death without a court probate proceeding. There are several types of nonprobate property, including:

(1) Property that transfers by form of ownership to the survivor at death (e.g., tenancy by the entirety real property, joint bank accounts, POD or TOD accounts);

(2) Property that transfers by beneficiary designation at death (e.g., payable on death accounts, IRA accounts, 401(k) accounts, 403(b) accounts, PERS benefits, annuities, life insurance); and

(3) Property having a statutory nonprobate status (e.g., Social Security and veterans benefits).

If an item is not probate property, it is ignored on all probate filings with the court. For example, it is not included in the probate inventory of the decedent’s assets.

RENOUNCING US CITIZENSHIP FOR TAX PURPOSES

Posted on February 8, 2012 by David C. Streicher

It is an understatement that US citizens living abroad are subject to a myriad of reporting requirements, such as Treasury Form TDF 90-22.1 (FBAR), IRS Form 8939 (FATCA), and IRS Form 3520 (foreign trusts). Worse yet, the severe penalties for failure to comply are almost beyond belief. For example, a US citizen living in Canada who fails to file Form TDF 90-22.1 can be fined $10,000 per unreported account per year — even if he or she owes no US income tax.

The onerous US reporting requirements have caused many expatriates to consider giving up their US citizenship or residency (green card). Many of these individuals have lived overseas for many years and have no plans to return to the US. In their view, the only benefit to retaining US citizenship is the ease of entering or leaving the US.

The mechanics of renouncing US citizenship or residency are relatively straightforward, as described below.

Renouncing Citizenship

A discussion about the procedure for renouncing US citizenship can be found in the Foreign Affairs Manual of the US Department of State (7 FAM 1260-1268), which is posted at http://www.state.gov/documents/organization/115645.pdf. Mechanically, the individual must make an appointment with the US consulate, complete and sign Forms DS 4079, 4080, 4081 and 4082 and relinquish the individual’s passport. The individual will then be furnished Form DS 4083, Certificate of Loss of Nationality of the United States.

Another note of caution: If the Department of Homeland Security determines that the renunciation is motivated by tax avoidance, the former citizen will be ineligible to receive visas and ineligible to be admitted to the US. See 7 FAM 1266 and 8 USC § 1182(a)(10)(E).

Renouncing Permanent Residency

To relinquish permanent residency (i.e., a green card), the individual must meet with the US consulate and provide a signed Form I-407 and surrender his or her green card.

US “Exit Tax”

A collateral consequence of giving up US citizenship or residency is that your US tax compliance will be scrutinized, and you may be liable under Code Section 877A for an “exit tax.” (Canadians will note that the US exit tax works in a manner similar to the Canadian deemed disposition rules.) In general, Section 877A applies only if the former US person (i) has a net worth over $2 million, (ii) paid US income taxes averaging over $147,000 for the prior five years, or (iii) does not certify on IRS Form 8854 that the person complied with all US tax obligations for the five prior years. The tax is imposed on net unrealized appreciation in excess of $636,000. Mechanically, a US person leaving the US must file IRS Form 8854 along with the individual’s final income tax return. Until Form 8854 is filed, the taxpayer must continue filing US tax returns on worldwide income — even if citizenship or residency has been renounced for immigration purposes. It warrants noting that Form 8854 cannot be filed until the taxpayer is in full compliance on prior years. (On the Form 8854, the taxpayer must certify under penalties of perjury that all returns have been filed and all taxes have been paid for the prior five years.)

In conclusion, renouncing US citizenship may make sense for individuals who no longer have any connection with the US. But there are various tax and immigration “side effects.” Thus, before you take that momentous step, you should consult experienced immigration and tax counsel.

US-CANADA ESTATE TAX TREATY

Posted on February 7, 2012 by David C. Streicher

US estate and gift tax laws apply to Canadians citizens who are permanent residents of the US (i.e., hold “green cards”) or own assets having a US situs. (In general, US assets include real or personal property located in the US and shares in US corporations.)

Fortunately, the US-Canada tax treaty eliminates US estate tax for most Canadians. Here are some general rules.

● A Canadian citizen whose worldwide estate is less than $5 million is not subject to US estate tax, no matter how much property has a US situs. See Article XXIXB2 of US-Canada Treaty.

● Even if a Canadian citizen’s worldwide wealth exceeds $5 million, there is no US estate tax if US situs property is less than $60,000. Code Section 2102(b) ($13,000 credit is commensurate with $60,000 of value)

● Finally, the treaty allows a marital credit for transfers to a Canadian surviving spouse equal to the lesser of (i) the utilized unified credit, or (ii) the estate tax otherwise payable on the property transferred to the Canadian spouse. See Article XXIXB3 of US-Canada Treaty. This effectively doubles the unified credit for married Canadians.

● With the enactment of “portability” at Code Section 2010(c), US persons can shelter $10 million from US estate tax with only minimal planning. However, in general, portability does not apply to nonresident aliens. It is an open question whether the US exemption under Article XXIXB2 is portable if transfers to a Canadian spouse already pass free of US estate tax by reason of the credit under Article XXIXB3.

OREGON HOURLY ATTORNEY RATES

Posted on January 24, 2012 by David C. Streicher

A threshold question from most prospective clients is “What is your hourly rate?” My answer is $275.

This begs the question of whether the rate is reasonable. In general, Portland attorneys with 20+ years of experience charge between $225 and $350 per hour. The rate depends on numerous factors, including the following:

Factors Influencing Hourly Rates

● Where is the attorney located? In general, downtown Portland attorneys are more expensive than those in smaller cities and outlying areas. This is largely a function of overhead and specialization. Rent is higher is downtown Portland, and attorneys in the downtown core tend to be more specialized. Along the same lines, hourly rates in Portland are less than those in Seattle or San Francisco.

● Where is the client located? If, for example, a Portland attorney provides services for a client in New York City (where the rates are perhaps 50% to 100% more) it is common to adjust the rate upward. Some attorneys have local and national rates. Surprisingly, it may be a win-win. The New York client pays fees much lower than if local counsel were used and the Portland attorney captures a higher rate, albeit much less than what a local attorney would have charged for the same work.

● How much experience does the attorney have? An experienced attorney is faster and more efficient than a beginner. There is less zig-zagging from start to finish. The attorney may have MS Word templates for similar projects and will probably know the answer to questions that would otherwise be researched. Unnecessary steps are avoided. Even if experienced and inexperienced attorneys charge the same price for a given project, the overall experience for the client is usually better with a seasoned lawyer, and the work product is of higher quality.

● Is the legal work specialized? Attorneys with specialization command a higher rate. For example, an attorney with detailed working knowledge of the federal, Oregon and Washington estate and gift tax laws normally has a higher rate than a general practice lawyer. The same might be true for an attorney experienced in the tax and business issues in transitioning / selling family or small businesses to employees, children or third parties. This is primarily a matter of supply and demand. Another factor is that work in specialty areas usually has higher risk of malpractice liability. Finally, the costs for subscriptions, reference books and continuing education for specialty areas are higher.

What Is a Reasonable Rate?

Instead of focusing on the hourly rate, consider focusing on the cost of the overall project. Although it may have been different in the past, most clients are now unwilling to hire an attorney who quotes an hourly rate and nothing more. It is perfectly reasonable to get a second opinion. Many attorneys (including myself) will discuss the project “off the clock” for a half hour or so and then provide tentative recommendations and fee estimates.

Some projects are hard to estimate. For example, I may be able to estimate that nine hours of attorney time, or roughly $2,500, will be needed to prepare the package of documents needed for the sale of a business. (The $2,500 would include both drafting and discussions with the client.) The wild card in estimating the fees is the other party to the transaction (or his attorney). If I end up mired in never-ending back and forth negotiations and have to revise the documents five or six times, the cost could be double or triple. Negotiations between attorneys are time-consuming because an attorney must discuss each matter with opposing counsel and then a second time with the client. Clients can avoid this inefficiency by contacting the other party directly and reaching an agreement on the deal points.

In summary, an attorney’s hourly rate should be based on experience and specialized knowledge. A quote for the overall cost of the project is usually more useful than the hourly rate. Consider obtaining a second opinion. Finally, references from clients (or other attorneys) who have worked with the attorney are valuable. If they were satisfied customers, chances are you will be too.

BENEFITS OF BECOMING A MINORITY OWNER OR MAJORITY OWNER OF A SMALL BUSINESS

Posted on January 22, 2012 by David C. Streicher

If given the opportunity, should you purchase a partial ownership (i.e., some of the outstanding shares) in a small business? What benefits do the shares confer? This article explores the benefits and power of majority and minority shareholders of a corporation. A similar (albeit different) analysis applies for members of a limited liability company.

When Ownership Confers Power

In general, the benefits of ownership hinge on whether you have sufficient shares to control the actions of the corporation, such as hiring employees, fixing compensation, declaring dividends, borrowing money, selling the corporation’s assets, acquiring other companies, etc. In general, these decisions are made by the corporation’s directors, normally by majority vote. (Occasionally, bylaws require a supermajority (e.g., 2/3) for certain decisions.) Thus, if you have sufficient shares to elect a majority of the directors, you alone control these fundamental decisions. An owner whose shares are insufficient to elect a majority of the directors is commonly known as a “minority shareholder,” and a shareholder controlling sufficient shares to elect a majority of the directors is often referred to as a “majority shareholder” or “controlling shareholder.”

Ownership ≠ More Compensation

Intuitively, one would think that purchasing shares of a small business will directly or directly create an income stream. It doesn’t — unless you are a majority shareholder. If you don’t control a majority of the shares, either through your own ownership or alliances with other owners, your shares are nearly irrelevant to your compensation. Your business skills (sales, management, technical) may be sufficient to confer control over your compensation (by threatening to leave), but not your minority block of shares.

Ownership ≠ Guaranteed Employment

Does owning shares guarantee a job? Not if you are a minority owner. Instead, the majority shareholder (through the directors he controls) is usually free to terminate your employment at any time. And this frequently occurs when there are disputes between minority and majority shareholders. Without a job, a minority shareholder has no means of generating an income stream. Unless the corporation pays dividends (which the directors will usually resist), the minority shareholder has funds tied up in an investment that generates no return.

Selling the shares to an outsider is seldom an option. A minority block of shares is nearly impossible to sell to anyone other than an existing owner. (Why would anyone pay money to be in your shoes?) Further, if the shares are covered by a buy-sell agreement, sales to outsiders are usually prohibited. This means that a minority shareholder is usually “stuck.” Buy sell agreements frequently give the corporation or majority shareholder the option, but do not create an obligation, to purchase the shares of a minority shareholder whose employment has terminated. The price is usually discounted and payable over a period of time.

Rights of Minority Shareholders

Even if you are a minority shareholder, you still have some leverage to liquidate your investment at a fair price. A sophisticated majority shareholder is always pondering “exit strategies,” meaning the ultimate disposition of the business. Perhaps the owner wants to build the business and eventually sell it. If so, the owner’s efforts will partially inure to the benefit of a passive investor, assuming the minority owner’s employment has terminated. This may be sufficient motivation to the majority owner to buy out the minority owner.

An uncooperative minority owner may also have the ability to frustrate corporate operations by refusing to guarantee leases and lines of credit. Most banks and landlords require a personal guarantee from all shareholders owning, say, 15% or more of the shares. Thus, a minority owner’s refusal to provide a personal guarantee may be sufficient leverage to compel a buyout.

When Should You Purchase Shares?

A 50-50 ownership arrangement may couple the benefits of ownership without the risk of being forced out through termination of employment. Neither owner has the right to change the arrangement existing when the ownership began. For example, an owner can’t unilaterally terminate the other’s employment, remove him or her as a director, or adjust salaries. (Sometimes this is addressed by “voting agreements” whereby each shareholder agrees to vote for the other as director, and not to take action to terminate the other’s employment.) The key disadvantage to equal ownership is that disputes may create a stalemate paralyzing the business. There may be no remedy if a disgruntled owner reduces his effort or hours, or just quits coming to work.

Before you buy a minority block of shares, you should identify your objectives. If compensation is the prime objective, you might consider limiting your participation to employment. Another alternative is to insist on a voting agreement that prevents the majority shareholder from terminating your employment or reducing your salary. Another angle might be to insist on a buy sell agreement that compels the corporation to purchase your shares on favorable terms if your employment is terminated. If your objective is to participate in the growth of the company and its eventual sale, guaranteed employment is less important. This might be the case if you believe the company is a candidate for an IPO.

Purchasing shares of a business is similar to starting a marriage. Getting in is much easier than getting out. Even if you are best friends with the other owner when you join the business, things may change down the road. Be cautions. Obtain references for your future business partners. Suppress the romantic euphoria of owning a business, and instead focus on practicalities.

Finally, hiring an experienced business lawyer before you invest is usually money well spent.

SELLING OR TRANSITIONING THE FAMILY BUSINESS

Posted on January 20, 2012 by David C. Streicher

I often work with clients who own a profitable business. It might be a commercial or retail store, a service business, a garbage collection route, a farm, or a manufacturing facility. The ultimate lurking question is what to do with the business when the client wants to retire or is forced to retire on account of health problems. Although every family business is different, there are several recurring issues.

Sell Before You Have To. Not infrequently, a client contacts me about selling a business when it is “too late.” If the client has health issues, potential buyers will inevitably sense the urgency and expect deep discounts. If the owner has neglected the business and the earnings are flat, the value may be nominal. The owner may argue that the business can easily be revitalized by increased sales efforts or tighter management, but it is nonetheless similar to selling a house needing repairs. Thus, the rule emerges: sell the business in an organized manner while it is doing well, rather than in a panic instigated by an emergency.

Are You Willing to Provide Financing? Most buyers are unable or unwilling to pay cash for a small business. Usually, the buyer does not have the cash. But even buyers with liquidity may prefer to hold back a portion of the purchase price until they determine that the seller’s representations are true. For example, are monthly sales roughly equal to those for prior periods? If the primary asset is a customer list, how many customers leave after the purchase? If the seller is required to introduce customers to the buyer, a deferred portion of the price is leverage to ensure the seller fully performs. In all events, if a seller wants cash, buyers are much harder (and take much longer) to find and the price tends to be lower. A cash sale is seldom feasible if the buyer is a key employee or family member.

Selling to Children. There are several advantages to selling (rather than giving) the business to children. One is that the parent will receive a payment stream akin to a pension. There is also a fairness aspect in that gifts to children active in the business tend to frustrate the conventional approach of treating all children equally. But there are also disadvantages. The creditor / debtor relationship between the parent and children can destroy family harmony (especially if the children default). Finally, the parent will lock in capital gains taxes on the sales proceeds, whereas there is no income tax hit if the business is held until death.

Selling to Key Employees (Other than Children). The primary issue when selling to key employees is whether they will be able to pay for the business — assuming a significant portion of the price is payable over time. This is especially relevant if there are other potential buyers with more business experience and a proven track record. An employee default will probably be attributable to a failure of the business, which might leave the seller with nothing. Thus, the seller must weigh the satisfaction of rewarding his employees with perhaps an increased risk of default.

Tax Complexities of Giving the Business to Children or Key Employees. Owners frequently wish to reward a key employee by giving him or her “a piece of the action,” i.e., shares in the business. The tax problem is that the shares are considered “wages.” The employee will have taxable income equal to the value of the shares, but no cash to pay the tax. Also, the employer is required to withhold Social Security and income tax. This is generally the case whether the shares are issued by the corporation (or LLC) or transferred directly from the owner to the employee. At least for children, there may be an exception to the “wages” characterization of the shares. A true gift, i.e., based on disinterested generosity, is not taxable compensation. A transfer of shares from a parent to a child may or may not be a gift; it depends on whether the shares are a reward for past or future services. Query: Can a transfer of shares to a child who is a driving force in the business ever be a “gift” if similar transfers (of shares or cash) are not made to inactive children? As you can imagine, the analysis is complicated and deserving of a review by a business attorney with a strong tax background.

In the next post I will cover the related topics of buy-sell agreements, asset vs. stock sales, securing payment with collateral or guarantees, non-compete covenants and other issues connected with the sale of a family business.

$5M GIFT TAX EXEMPTION (AND “CLAWBACK”) – URGENT OPPORTUNITY?

Posted on January 14, 2012 by David C. Streicher

I continually hear of the urgency in utilizing the $5M gift tax exemption, based on the paranoia that Congress will reduce it (or worse yet, let it return to $1M). For a couple of reasons, I think the benefit of making large gifts (to protect against a rollback) is speculative at best. First, the “no tax increase” climate in Congress suggests a rollback is unlikely. Second, even if there is a rollback, it is necessary to make huge gifts of high-basis assets to realize a tax savings. Finally, the potential estate tax savings is often recaptured by the carryover basis attaching to lifetime gifts.

As the laws stand now, lifetime gifts are added back at death. This add back is commonly known as the “clawback.” In other words, if someone with $10M gives away $5M the day before death, the estate tax at death is computed on an estate of $10M and an exemption of $5M. The tax would be $1.75M. [($10M - $5M exemption) X .35] If the estate was only $5M, the clawback of $5M would cause the estate tax to be computed on a $5M estate and (after the $5M exemption) the tax would be zero. Easy enough.

Now let’s change the facts. Suppose the estate is only $5M and the individual gives away $5M in 2012 and dies in 2013, when the exemption is only $1M. If the clawback is $5M, the estate tax would be computed on a tax base of $5M, and (after an exemption of $1M) the tax would be $1.4M. Almost everyone agrees this was not intended by Congress. In other words, those making gifts now should not end up with a dysfunctional situation in which the estate is zero and the tax is $1.4M. Although there are arguments on both sides of the spectrum, the most persuasive position is that the tax will be zero, inasmuch as the clawback would be limited to the exemption in effect at death. Thus, the estate tax would be computed on a tax base of $1M and (after the exemption of $1M) the tax would be zero. Thus, the lifetime gift of $5M would save tax of $1.4M, which is a big deal.

Let’s change the facts a little more. Assume the exemption is rolled back from $5M to $4M. Based on the analysis above, the clawback would be limited to $4M, and once again the tax would be zero. Thus, the decedent would save $350,000 of tax by making $5M of lifetime gifts. When we run examples, the general rule emerges: If the clawback is limited to the exemption in effect at the time of death, the decedent’s tax savings from lifetime gifts is 35% of the excess of (i) lifetime gifts, over (ii) the exemption in effect at death.

Examples: [based on individual who has already made $1M of lifetime gifts and has a remaining estate of $8M]

Suppose an individual has an $8M estate and has already made $1M of lifetime gifts. If he does nothing, his federal tax at death is roughly $1.4M, being 35% of the excess of $9M over the exemption of $5M. (This assumes a clawback of $1M and an exemption of $5M.) If he makes another $4M of lifetime gifts the result is the same. His estate at death is $4M, but there is a clawback of $5M.

Suppose the exemption changes to $3M, and he makes an additional $2M of lifetime gifts, total gifts are $3M. His estate at death is only $6M. The clawback is limited to the exemption in effect at death, or $3M. Thus, his estate tax is computed with respect to $9M (with a $3M exemption), and the tax is $2.1M. If he had done nothing, his tax would have been computed with respect to $9M (assuming a $1M clawback), and his tax would have been $2.1M. Thus, the additional gifts did not save anything, and have lost a stepped up basis.

To summarize:

If he makes $2M of additional lifetime gifts, and the exemption changes to $4M, $3M, $2M or $1M, the tax savings will be $0, $0, $350,00, $700,000 and $1.05M, respectively.

If he makes $3M of additional lifetime gifts, and the exemption changes to $4M, $3M, $2M or $1M, the tax savings will be $0, $350,00, $700,000, $1.05M, and $1.4M, respectively. Query: Does he have $3M of high basis assets to give away?

If he makes $4M of additional lifetime gifts, and the exemption changes to $4M, $3M, $2M or $1M, the tax savings will be $350,00, $700,000, $1.05M, $1.4M and $1.75M, respectively.

But we are left with the basic rule: There is a tax savings only if the lifetime gifts exceed the exemption in effect at death. Thus, assuming the exemption decreases to $4M, he will realize a tax savings only to the extent he makes more than $3M of additional gifts.

We must also keep the income tax ramifications in mind. The recipient of a lifetime gift takes on a “carryover” cost basis equal to that of the person making the gift. Conversely, recipients of death gifts receive a stepped-up basis equal to the value at the date of the decedent’s death. Thus, if an individual makes lifetime gifts of low basis assets, the eventual capital gains taxes to the recipient will offset some or all of the potential death tax savings.

In summary, the tax savings from big gifts is speculative, and based on the assumption that the exemption will decrease. One can persuasively argue that the potential tax benefit is nominal because Representative Eric Cantor (and others) will resist any effort to raise taxes by decreasing the estate tax exemption below its current level of $5M. Also, few individuals have sufficient high basis assets (i.e., $2M +) to make large gifts “work.”

Determining whether to make substantial lifetime gifts is complicated and not a no-brainer. You should consult an experienced estate planning lawyer.

IRS Fact Sheet 2011-13 — FBAR RELIEF?

Posted on January 3, 2012 by David C. Streicher

The IRS has just issued the following “fact sheet” on reasonable cause for delinquent filing of Form TDF 90-22.1. The main thrust is that FBAR penalties will usually be abated when no income tax (or a “deminimis” amount) is owing on the delinquent Forms 1040. A detailed analysis of Fact Sheet 2011-13 will be provided in the next post.

Information for U.S. Citizens or Dual Citizens Residing Outside the U.S.

FS-2011-13, December 2011

The IRS is aware that some taxpayers who are dual citizens of the United States and a foreign country may have failed to timely file United States federal income tax returns or Reports of Foreign Bank and Financial Accounts (FBARs), despite being required to do so. Some of those taxpayers are now aware of their filing obligations and seek to come into compliance with the law. This fact sheet summarizes information about federal income tax return and FBAR filing requirements, how to file a federal income tax return or FBAR, and potential penalties.

Note that penalties will not be imposed in all cases. As discussed in more detail below, taxpayers who owe no U.S.tax (e.g., due to the application of the foreign earned income exclusion or foreign tax credits) will owe no failure to file or failure to pay penalties. In addition, no FBAR penalty applies in the case of a violation that the IRS determines was due to reasonable cause.

This fact sheet is provided for information purposes only, and the topics discussed may or may not apply to a particular taxpayer’s situation. The IRS continues to consider the topics discussed in this fact sheet and will provide additional information as it becomes available.

4. FBAR filing requirement

As a United States citizen, you may be required to report your interest in certain foreign financial accounts on Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR). For information about FBAR reporting requirements, including reporting exceptions, see Form TD F 90-22.1 and the IRS FBAR Frequently Asked Questions.

5. How to file an FBAR

For information about how and where to file an FBAR, see Form TD F 90-22.1 and the IRS FBAR Frequently Asked Questions.

If you learn you were required to file FBARs for earlier years, you should file the delinquent FBARs and attach a statement explaining why they are filed late. You do not need to file FBARs that were due more than six years ago, since the statute of limitations for assessing FBAR penalties is six years from the due date of the FBAR. As discussed below, no penalty will be asserted if IRS determines that the late filings were due to reasonable cause. Keep copies, for your record, of what you send.

6. Possible penalties for failure to file FBAR

If you fail to file an FBAR, in the absence of reasonable cause, you may be subject to either a willful or non-willful civil penalty. Generally, the civil penalty for willfully failing to file an FBAR can be up to the greater of $100,000 or 50 percent of the total balance of the foreign account at the time of the violation. See 31 U.S.C. § 5321(a)(5). Note that this penalty is applicable only in cases in which there is willful intent to avoid filing. Non-willful violations that the IRS determines are not due to reasonable cause are subject to a penalty of up to $10,000 per violation. There is no penalty in the case of a violation that IRS determines was due to reasonable cause. For more information about the FBAR penalty, see Form TD F 90-22.1. For information about the reasonable cause exception to the FBAR penalty, see IRM 4.26.16, Report of Foreign Bank and Financial Accounts (FBAR).

Example 3: Same facts as Example 1, except that the highest balance in Taxpayer’s checking account exceeded $10,000 and, after reading recent press and thus learning of his FBAR filing obligations, Taxpayer filed an accurate, though late, FBAR. The FBAR was accompanied by a written statement explaining why Taxpayer believed the failure to file the FBAR was due to reasonable cause. The IRS will determine whether the violation was due to reasonable cause based on all the facts and circumstances. Taxpayer’s explanation for why he failed to timely file an FBAR appears reasonable in view of the facts and circumstances of the case. Since the IRS determined that the FBAR violation was due to reasonable cause, no FBAR penalty will be asserted.

Factors that might weigh in favor of a determination that an FBAR violation was due to reasonable cause include reliance upon the advice of a professional tax advisor who was informed of the existence of the foreign financial account, that the unreported account was established for a legitimate purpose and there were no indications of efforts taken to intentionally conceal the reporting of income or assets, and that there was no tax deficiency (or there was a tax deficiency but the amount was de minimis) related to the unreported foreign account. There may be factors in addition to those listed that weigh in favor of a determination that a violation was due to reasonable cause. No single factor is determinative.

Factors that might weigh against a determination that an FBAR violation was due to reasonable cause include whether the taxpayer’s background and education indicate that he should have known of the FBAR reporting requirements, whether there was a tax deficiency related to the unreported foreign account, and whether the taxpayer failed to disclose the existence of the account to the person preparing his tax return. As with factors that might weigh in favor of a determination that an FBAR violation was due to reasonable cause, there may be other factors that weigh against a determination that a violation was due to reasonable cause. No single factor is determinative.

Current IRS procedures state that an examiner may determine that the facts and circumstances of a particular case do not justify asserting a penalty and that instead an examiner should issue a warning letter. See IRM 4.26.16, Report of Foreign Bank and Financial Accounts (FBAR). The IRS has established penalty mitigation guidelines, but examiners may determine that a penalty is not appropriate or that a lesser (or greater) penalty amount than the guidelines would otherwise provide is appropriate. Examiners are instructed to consider whether compliance objectives would be achieved by issuance of a warning letter; whether the person who committed the violation had been previously issued a warning letter or has been assessed the FBAR penalty; the nature of the violation and the amounts involved; and the cooperation of the taxpayer during the examination.

Example 4: Taxpayer is a United States citizen who lives and works in Country B as a computer programmer. Taxpayer has checking and savings accounts with a bank that is located in the city where he lives. The aggregate balance of the checking and savings accounts is $50,000 during the tax year. Taxpayer complied with Country B’s tax laws and properly reported all his income on Country B tax returns. Taxpayer failed to file federal income tax returns and failed to file FBARs to report his financial interest in the checking and savings accounts. After reading recent press and thus learning of his federal income tax return and FBAR reporting obligations, Taxpayer filed delinquent FBARs, reporting both foreign accounts, and attached statements to the FBARs explaining that he was previously unaware of his obligation to report the accounts on an FBAR. Taxpayer also filed federal income tax returns properly reporting all income and no tax was due. The IRS will determine whether the FBAR violation was due to reasonable cause based on all the facts and circumstances. Taxpayer had a legitimate purpose for maintaining the foreign accounts, there were no indications of efforts taken to intentionally conceal the reporting of income or assets, and no tax was due. Taxpayer’s explanation for why he failed to timely file an FBAR appears reasonable in view of the facts and circumstances of the case. Since the IRS determined that the FBAR violation was due to reasonable cause, no FBAR penalty will be asserted.

7. New reporting requirement for foreign financial assets

A new law requires U.S. taxpayers who have an interest in certain specified foreign financial assets with an aggregate value exceeding $50,000 to report those assets to the IRS. This reporting will be required beginning in 2012. Taxpayers who are required to report must submit Form 8938 with their tax return. See Notice 2011-55 for additional information about this reporting requirement under IRC section 6038D.

ESTATE TAX RELIEF UNDER US-CANADA TAX TREATY

Posted on December 23, 2011 by David C. Streicher

The Internal Revenue Code is harsh on its treatment of transfers of wealth to or by nonresident aliens. But the US-Canada tax treaty provides relief to Canadians.

General Rules. There is no estate tax marital deduction for transfers at death to spouses who are not US citizens. (Conversely, there is an unlimited marital deduction if the spouse is a US citizen.) Along the same lines, the exemption for lifetime gifts to a spouse who is not a US citizen is limited to roughly $133,000. Upon the death of an unmarried nonresident alien, the estate tax exemption is only $60,000, rather than $5M. Nonresident aliens are allowed the $13,000 annual exclusion for gift tax purposes, but have no gift tax exemption (whereas US citizens have a $5M exemption).

The US-Canada Tax Treaty. The treaty is an overlay of sorts to the Internal Revenue Code, and “trumps” the Code when the two are inconsistent. Relief specific to Canadians includes the following.

No US Estate Tax if Canadian’s Worldwide Estate Is Under $5M. In general, a Canadian citizen whose worldwide estate is less than $5 million is not subject to US estate tax, no matter how much property has a US situs. See Article XXIXB2 of US-Canada Treaty. Mechanically, the allowable US exemption is a fraction of $5M based on the ratio that the decedent’s US property bears to the decedent’s worldwide property. Thus, for example, if the decedent’s US and worldwide estates were $4M and $5M, respectively, the allowable US exemption would be $4M.

Bonus Relief for Transfers to Canadian Spouses. The treaty allows an estate tax credit for transfers to a surviving spouse equal to the lesser of (i) the estate tax on the portion of the $5M exemption that is utilized, or (ii) the estate tax otherwise payable on the property transferred to the spouse. See Article XXIXB3 of US-Canada Treaty. This effectively doubles the exemption described in the preceding paragraph.

No Gift Tax Relief. The treaty does not soften the harsh rules governing lifetime gifts.

Treaty Does Not Affect Oregon or Washington Estate Tax. The Oregon and Washington estate tax laws are based solely on the Internal Revenue Code, without modification from treaties. Thus, Oregon and Washington estate taxes are computed as if there is no US-Canada tax treaty.

Conclusion. When estate planning (or income tax planning) for Canadians, always look to the US-Canada treaty.

FEDERAL ESTATE TAX EXCLUSION IS $5,120,000 IN 2012

Posted on December 21, 2011 by David C. Streicher

Pursuant to Revenue Procedure 2011-52, the IRS has announced that the estate tax exemption will be $5,120,000 for deaths occurring in 2012. The lifetime gift tax exemption will also increase to $5,120,000 in 2012.

However, the federal annual exclusion for gifts remains at $13,000 per person.

Neither Oregon nor Washington is changing their estate tax exemptions of $1M and $2M, respectively. (Neither state has a gift tax.)

IS OREGON’S ESTATE TAX HIGHEST IN THE US?

Posted on December 16, 2011 by David C. Streicher

Is Oregon’s estate tax the highest in the nation? No. Is it one of the highest? Yes, but Oregon provides a much-needed tax break for modest estates.

Background. There are roughly 20 states that impose an estate tax. The exact number is a moving target. The attached chart illustrates the tax burden imposed by each state on various levels of wealth. A key assumption in the chart is that all of the decedent’s wealth passes to children. (Different rates and exemptions apply for transfers to spouses, siblings, nieces, cousins and more remote relatives.)

The Calculations Are Complicated. Oregon is one of 13 states that use a mystifying calculation pegged to a federal estate tax credit phased out years ago. The rate is the lower of (1) the hypothetical federal estate tax if the exemption is $1M, and (2) the hypothetical amount allowed as a state death tax credit (against federal estate tax) in 2001. Translated into numbers, no tax is due on the first $1M. Unbelievably, a 41% rate applies to the layer of wealth between $1M and $1,093,785. The excess over $1,093,785 is taxed at rates beginning at 5.6% and gradually inching up to 16% for wealth over $10.1M. Thus, an estate of $1M pays no tax at all, but an estate of $1.1M pays $38,800. The remaining seven states use a more straightforward calculation with relatively smooth rates.

Oregon reduced the punitive 41% rate to 10% through legislation (HB 2541) effective in 2012. This will reduce Oregon’s tax on a $1.1M estate from $38,800 to $10,000. The Oregon legislature required HB 2541 to be tax neutral, so this tax cut on small estates is offset by a modest tax increase on larger estates. For example, estates under $1.946M will pay less tax in 2012 and estates over that amount will pay slightly more. It is an open question whether other states will follow Oregon’s lead and remove the 41% “gouge” extracted from relatively small estates.

Exemption / Filing Threshold. Eight states (including Oregon) impose no tax and have no filing requirement for estates up to $1M. Eight states have more generous exemptions than Oregon: WA, IN, IL and CT have a $2M exemption; VT has a $2.75M exemption; HI and DE have a $3.5M exemption; and NC has a $5M exemption. Finally, four states (NJ, OH, PA and RI) have exemptions of less than $1M.

Significance of Exemptions Can Be Misleading. Oregon and NC both impose a tax of $1,067,600 on an estate of $10M, yet NC has an exemption of $5M and Oregon’s exemption is only $1M. Hawaii also imposes a tax of $1,067,600 on a $10M estate even though its exemption is $3.5M. These states “catch up” with Oregon by imposing huge rates on selected layers of wealth in excess of the exemption. For example, NC imposes a 35% tax on the layer of wealth between $5M and $6M. [The NC tax on estates of $5M and $6M estate is $0 and $350,000, respectively] Along the same lines, HI’s rate is 45% on the layer of wealth between $3.5M and $4M. [The HI tax on estates of $3.5M and $4M is $0 and $225,000, respectively]

Highest Marginal Rate Is Misleading. The highest marginal rate is not always the rate at the bottom of the rate schedule. For example, HI’s rate on wealth in excess of $10.1M is 16%, yet HI’s rate is 45% on wealth between $3.5M and $4M. NC has the same dichotomy. Since WA’s rate is 19% on wealth over $9M, does WA have the highest rate in the nation? It depends…..

The Highest Taxing States Are:

Estates of $1M: PA, at $45,000.

Estates of $1.1M: IN, at $52,250

Estates of $3M: IN, at $232,250. OH is 2nd at $184,700. Currently, nine states (including Oregon) are tied for 3rd at $182,000. Starting in 2012, Oregon will be in 2nd place alone, with $205,000.

Estates of $5M: IN, at $432,250. Currently, 12 states (including Oregon) are tied for 2nd at $391,600. Starting in 2012, OR will be in 2nd place alone, with $425,000.

Estates of $10M: WA, at $1,255,000. Currently, 13 states (including Oregon) are tied for 2nd at $1,067,600. Starting in 2012, OR will be in 2nd place alone, with $1,102,500.

Summary Through End of 2011. For estates of $1.1M, seven states charge the same tax ($38,800) as Oregon; 10 states charge less, and three states charge more. For estates of $3M, nine states charge the same tax ($182,000) as Oregon; 10 states charge less, and one state charges more. For estates of $5M, 12 states charge the same tax ($391,600) as Oregon; seven states charge less, and one state charges more. Finally, for estates of $10M, 13 states charge the same tax ($1,067,600) as Oregon; 6 states charge less, and one state charges more.

2012 Changes. Starting in 2012, Oregon fares better on some comparisons and worse on others. On the positive side, Oregon’s tax on estates of $1.1M will be substantially less than all but one of other the states with a $1M exemption. Its rates on estates of $3M, $5M and $10M will be slightly more (roughly $23,000 to $35,000 more) than most other states. For extremely wealthy taxpayers, Oregon’s tax is not significantly higher than other states. For example, Oregon’s $1,102.500 tax on an estate of $10M is only $35,000 more than the tax imposed by 13 other states. And Oregon’s tax of $1,102,500 is $152,500 less than its neighbor to the north,Washington.

Conclusion. Starting in 2012, Oregon’s rates for large estates will be slightly higher than most other states (except for Washington) that impose an estate tax, but not nearly enough higher to justify moving to any of the other states. The fact that state estate taxes are deductible when computing federal estate taxes further softens the difference.

STATE DEATH (ESTATE) TAX RATES

Posted on December 16, 2011 by David C. Streicher

This chart summarizes the estate tax laws of the 20 states that currently impose an estate tax. Included are the exemptions, top rate, and computations of tax liability for estates of $1M, $1.1M, $3M, $5M and $10M.

COMPARISON OF STATE ESTATE TAXES (as of December, 2011)
Note: Some states have different rates for various classes of beneficiaries. This chart assume all wealth passes to children.

	EXEMPTION	$1M	$1.1M	$3M	$5M	$10M	Top Rate*

CT	2,000,000	0	0	72,000	229,800	736,800	12%
DE	3,500,000	0	0	0	391,600	1,067,600	16%
DC	1,000,000	0	38,800	182,000	391,600	1,067,600	16%
HI	3,500,000	0	0	0	391,600	1,067,600	16%
IL	2,000,000	0	0	167,279	352,158	926,923	15.2%
IN	2,000,000	42,500	52,250	232,250	432,250	932,250	10%
ME	1,000,000	0	38,800	182,000	391,600	1,067,600	16%
MD	1,000,000	0	0	182,000	391,600	1,067,600	16%
MA	1,000,000	0	38,800	182,000	391,600	1,067,600	16%
MN	1,000,000	0	38,800	182,000	391,600	1,067,600	16%
NC	5,000,000	0	0	0	0	1,067,600	16%
NJ	675,000	33,200	38,800	182,000	391,600	1,067,600	16%
NY	1,000,000	0	38,800	182,000	391,600	1,067,600	16%
OH	338,333	44,700	51,700	184,700	324,700	674,700	7%
OR (2012)	1,000,000	0	10,000	205,000	425,000	1,102,500	16%
OR (2011)	1,000,000	0	38,800	182,000	391,600	1,067,600	16%
PA	none	45,000	49,500	135,000	225,000	450,000	4.5%
RI	859,350	33,200	38,800	182,000	391,600	1,067,600	16%
TN	1,000,000	0	6,100	178,400	368,400	843,400	9.50%
VT	2,750,000	0	0	112,500	391,600	1,067,600	16%
WA	2,000,000	0	0	100,000	390,000	1,255,000	19%

* “Top Rate” means the marginal rate on each dollar in excess of $10M, except that the threshold is actually $10.1M for states showing a marginal rate of 16%.

FBAR RELIEF FOR CANADIANS?

Posted on December 15, 2011 by David C. Streicher

According to an article published December 2, 2011 in The Globe and Mail, a Canadian periodical, the IRS might be lenient on US citizens (and green card holders) living in Canada who didn’t disclose their “offshore” accounts by filing Form TDF 90-22.1. (This form is sometimes known as the “FBAR” form, based on an abbreviation for “foreign bank account reporting.”) David Jacobson, the US Ambassador to Canada, was quoted as saying that “if … you don’t owe taxes to the US, and you file your return[s] and they show you don’t owe taxes, there aren’t going to be any penalties for having filed late.” He reportedly also said the IRS position would be published within “weeks.” Presumably he means there will be no penalty for late filed FBAR forms so long as late filed Forms 1040 demonstrate that no tax is due.

As is usually the case, the Jacobson comments raise questions. For example, will the IRS impose an FBAR penalty if a US citizen living in Canada files Forms 1040 for 2003 – 2010 and a tax of $500 is owed for only one of the eight years? What if the tax owed is only $100?

The December 9, 2011 deadline (including a 90-day extension) for completing all filings connected with the Offshore Voluntary Disclosure Initiative (“OVDI”) has long since passed. By way of background, the OVDI program offered full resolution in exchange for a penalty equal to a percentage of the highest aggregate balance of the taxpayer’s offshore accounts during the last 8 years. The lowest possible penalty rate was 5%. My experience is that only a small percentage of US citizens living in Canada made OVDI filings. As one client stated, “I have life savings of $500,000 and I doubt that I owed any US tax during 2003 – 2010. Why should I pay a $25,000 penalty for failure to file a one page form each year?”

A number of individuals frantically filed Forms 1040 and TDF 90-22.1 for 2003 – 2010 prior to the OVDI deadline of September 9, 2011. This is sometimes referred to as a “quiet disclosure.” The OVDI instructions (at FAQ 17) indicate that those who filed US returns for 2003 – 2010 and paid all tax will not be liable for FBAR penalties on account of failing to file Form TDF 90-22.1 on time. However, some believe the leniency described at FAQ 17 only applies if the Forms 1040 were filed timely and all taxes were paid at that time.

Other individuals are still filing their delinquent Forms 1040 and TDF 90-22.1, and are hoping to avoid the penalty by showing reasonable cause for failing to file Form TDF 90-22.1 on time. Persuasive grounds for reasonable cause might exist if the individual hired a well qualified tax preparer who (knowing they were US citizens) did not advise them of the requirement to file Form TDF 90-22.1. One can only speculate how rigidly the IRS will scrutinize reasonable cause explanations. If the IRS rejects the explanation and imposes the full penalty, the maximum fine (absent willfulness) is $10,000 per unreported account per year. IRS service centers are presently swamped with OVDI filings, and it is too early to discern the fate of penalty waiver requests.

Finally, a number of individuals are taking their chances filing Forms 1040 and TDF 90-22.1 starting with the 2011 taxable year and not looking back. Only time will tell whether they dodge the bullet.

ESTATE PLANS FOR FARMERS AND BUSINESS OWNERS

Posted on December 14, 2011 by David C. Streicher

Now that the federal estate tax exemption has increased to $5M per spouse, and is “portable,” death taxes are of less concern to family business owners. (“Portable” means that the unused exemption from the first spouse to die may be used by the surviving spouse, which effectively creates a $10M exemption for married couples.) Although Oregon and Washington still have an estate tax (with exemptions of $1M and $2M per spouse, respectively), the state death tax bill should not force the sale of the business.

Planning for business owners differs dramatically depending on whether children or other family members are active in the business. If they are, efforts should be made to transfer the business to them. Otherwise, the business just represents generic value to be divided among the heirs.

If the owner’s will allocates all of the business to active children, we are left with the question of whether there are sufficient “other” assets to equalize the inactive children. Usually the answer is “no.” Farmers in particular are notoriously land rich but cash poor. Several observations and ideas come to mind. If the owner is insurable, he might consider purchasing the life insurance naming the inactive children as beneficiaries. But if the owner is advanced in age, the cost may be prohibitive or the owner may have health issues making it impossible to buy life insurance. Another angle is to allocate a portion of the business to the inactive children, but give the active children a “call” option at the owner’s death to purchase the shares at a reasonable price over an extended period of time.

If the business is valuable and, say, only one of five children is active, the owner might consider selling the business during his life to a buyer willing to give the active child a long-term employment contract. The sales proceeds can easily be divided at the owner’s death. If the owner is the driving force in the business, and it is doubtful the child can successfully run the business, the owner should strongly consider selling the business while both it and the owner are healthy. Otherwise, the owner’s death or an abrupt change in health may make the business a worthless asset.

Does “fair” mean “equal?” Many believe it does not. The children active in the business may be responsible for its success, especially as the parent takes a back seat. Thus, fairness may dictate that their inheritances be larger, since they will be receiving value they created. An overlapping nuance is the “sweat equity” of the active children. It is common for owners to pay below market compensation to family members based on the understanding that they will eventually end up with the business. (But the owner frequently does not tell this to the inactive children.) Finally, if equalization is impracticable, the owner should mention in his will the reasons (such as those above) why his wealth is divided unequally.

Valuation can be tricky. Suppose the owner has two children, one of whom is active in the business. Over several years the owner gives 52% of his shares to the active child, leaving the owner with 48% at death. When valuing the 48% interest, a minority interest discount of perhaps 35% will apply. Should this discounted value be used in equalizing the active child with the inactive child? Or should a value equal to 48% of the value of 100% of the shares be used?

There are endless scenarios in family business matters, and it would take a book to cover them all. The most important advice to a business owner is to make some hard decisions. The worst situations are those in which the owner concludes that the children “can work it out among themselves.” Unfortunately, “working it out” may mean lawsuits. Instead, the owner should make decisive plans and mention this to his children during life or in his will. Otherwise, each child will have a different view of what the owner intended.

Finally, it is imperative that a business owner use an experienced and competent lawyer and accountant when integrating business planning with his estate plan.

A/B TRUSTS ARE OBSOLETE IN OREGON AND WASHINGTON- USUALLY

Posted on December 13, 2011 by David C. Streicher

General Overview. For the last 20 years, variations of the A/B Trust have been the cornerstone of estate tax planning for married couples. In a nutshell, the A/B Trust structure prevents all or a portion of the wealth from the first spouse to die from being included in the surviving spouse’s estate — even though she has the use of the money for the rest of her life.

Here’s how it works. (To simplify, I refer to the first spouse to die as the “husband,” and the surviving spouse as the “wife.”) The husband’s will causes his wealth to split into two shares at his death. The “B Trust” is allocated the largest amount that may pass free of federal estate tax. This was originally only $600,000. The rest of the husband’s estate is allocated to the “A Trust.” (B Trusts are frequently referred to as a “credit shelter trusts” or “bypass trusts,” and A Trusts are frequently referred to as “marital trusts” or “QTIP trusts.” For example, if the husband’s estate is $1M and the exemption is $600,000, then $600,000 is allocated to the B Trust and $400,000 is allocated to the A Trust. The executor claims the estate tax marital deduction (by making a “QTIP” election) for the amount allocated to the A Trust, but not for the B Trust. (Thus, no tax is due at the husband’s death.) The distribution standards in the A Trust and B Trust are similar: the wife receives all income along with principal as needed for her health, education, support and maintenance. When the dust settles, the wife’s estate (when she dies) includes her separate assets and the residue of the A Trust, but not any of the B Trust. Thus, the B Trust is a mechanism for giving the wife the use of $600,000 without having to include these assets in her estate at death. Many A/B wills distribute the wife’s share of the husband’s estate outright to her, rather than to the A Trust.

Potential Federal Estate Tax Savings Under Prior Law. B trusts serve a purpose if we somehow know that removing assets from the wife’s estate will reduce estate taxes at her death. For example, if the husband and wife each own $1M, and the exemption is only $600,000, a B Trust will leave the wife with $1.4M of wealth, rather than $2M, at death. When the marginal estate tax rate was 45%, this saved $270,000 of tax. But not any more.

No Federal Estate Tax Savings Under Current Law. The lifetime exemption is now $5M, and is “portable” between spouses. In other words, the unused exemption of the deceased husband may be used by the wife. For example, if each spouse owns $5M, and all of the husband’s wealth passes to the wife, she will have a $10M exemption at her death. This means that with without bothering with A/B trusts a married couple can now pass $10M to their children without any federal estate tax. Thus, portability has effectively made A/B trusts obsolete for federal estate tax purposes.

Potential Oregon and Washington Estate Tax Savings. Unfortunately, neither Oregon nor Washington has adopted portability. To make matters worse, the Oregon and Washington exemptions are only $1M and $2M, respectively. Thus, unless the exempt amount (i.e., $1M or $2M) is diverted to a B Trust, it is included in the wife’s estate. For example, if each spouse owns $1M, and a B Trust is not used, the wife’s estate will be about $2M, which will attract about $100,000 of Oregon estate tax. But if the husband’s $1M had been sheltered by a B Trust, no Oregon estate tax would be owed at the wife’s death. Thus, while a B Trust provides no federal estate tax benefit, it may save taxes for Oregon and Washington estate tax purposes.

Disadvantages to B Trusts There are several drawbacks to B Trusts, including the following:

Administrative Burden – The funds in the B Trust must be separately accounted for and separate trust income tax returns (forms 1041 and 41) must be filed every year. If the wife survives the husband by, say, 20 years, this administrative burden may outweigh the potential Oregon estate tax savings of perhaps $100,000 at the wife’s death. (Most spouses do not enjoy having to fuss with the complexity of separate accounts and separate tax returns for rest of their lives.) And it is possible that Oregon will increase its exemption sufficiently (perhaps to $2M) that a B trust will not be needed to protect the wife’s estate from death tax. A number of widows or widowers in their 50s or 60s have opted not to bother with a B Trust. The potential $100,000 tax savings — after their death — is not worth the administrative burden to them.

Lower Adjusted Basis – The assets held in a B Trust have a cost basis equal to the value at the husband’s death. Thus, any appreciation during the remainder of the wife’s life will be taxed when the assets are sold. Conversely, if the same assets pass outright to the wife and are sold after her death, there is no gain or loss. The reason is that the assets in the wife’s estate at death take on a new basis equal to fair market value at death. For example, suppose each spouse owns $1M in wealth. All of the husband’s $1M passes to a B Trust. The wife’s estate will be only $1M at death and no Oregon estate tax will be owed. But suppose the B Trust assets appreciate to $1.5M. Since the basis is only $1M, there will be capital gain of $500,000 and perhaps $120,000 of tax when the B Trust assets are sold. (This assumes a combined federal and Oregon capital gains rate of 24%.) Had the B Trust assets passed outright to the wife, the sale for $1.5M would have generated no capital gains tax. While the B Trust costs the family additional income taxes of perhaps $120,000, it saves perhaps $150,000 of Oregon estate tax, i.e., about 10% of the $1.5M in the B Trust at the wife’s death. But the net savings is only perhaps $30,000.

Current Benefits of B Trusts

Oregon and Washington Estate Tax Savings – The key benefit of a B Trust is state death tax savings.

Disinheritance Protection – A nontax benefit of a B Trust is that it prevents the wife from changing the dispositive scheme. In a second marriage situation, this means preventing the wife from disinheriting the husband’s children. Further, the wife cannot pass family wealth to a new spouse at her death. This can be valuable.

Creditor Protection - Another potential advantage is creditor protection. If the wife suffers financial reverses, the creditors cannot touch the B Trust.

Summary. A/B trusts are unnecessary for federal estate tax purposes. However, this structure may still be useful for reducing or eliminating the modest hit of Oregon or Washington estate taxes. The potential Oregon and Washington estate tax savings must be weighed against additional capital gains taxes if the B Trust assets appreciate after the husband’s death.

LIVING TRUSTS VS. WILLS

Posted on December 6, 2011 by David C. Streicher

Everyone should have a living trust. Avoid probate at all costs. Avoid horrible death tax bills. Avoid exorbitant executor fees and legal fees. The list goes on and on. While there is a grain of truth in these arguments, you should take a closer look before expending resources on a living trust. Here’s why.

You Should Avoid Probate at All Costs – This paranoia seldom rings true. For most married couples, there is no probate when the first spouse dies. (This is because their assets pass free of probate by reason of joint ownership or beneficiary designation.) Thus, the probate avoided by a living trust does not occur until the surviving spouse dies.* If both spouses are in their 50s, for example, the probate avoidance cost savings may not be realized for 30 years or more. But if the clients are in their 80s, the probate avoidance benefit can be a huge advantage.

* There is an exception to the statement that a probate is only required at the death of the surviving spouse. A probate is also required upon the death of the first spouse to die if a “credit shelter trust” will be established. A credit shelter trust is a tax planning vehicle to hold part of the decedent’s wealth so that it is not included in the surviving spouse’s estate for estate tax purposes. Credit shelter trusts are usually unnecessary for federal estate tax purposes, because “portability” of the federal exemption vests the surviving spouse with a $10M exemption. However, since Oregon’s estate tax exemption is only $1M, and Oregon does not allow portability, some clients choose to establish a credit shelter trust to keep up to $1M of the decedent’s wealth out of the survivor’s estate for Oregon purposes. (Other clients feel the modest tax savings does not warrant the administrative burden of maintaining a credit shelter trust for the rest of the survivor’s life.)

Establishing a Living Trust is Easy - Wrong. The time and disruption to clients from re-titling their assets — which must be done for a living trust — is painful, and they dread it. Bank and brokerage accounts must be closed and new accounts opened; deeds must be prepared and recorded; stock certificates must be exchanged with transfer agents. Instead of “Jane Smith and John Smith,” the owner becomes “Jane Smith and John Smith, Co-Trustees of the Jane and John Smith Living Trust under agreement dated 12/05/2011.” And if you forget to transfer a single asset (as is frequently the case), the probate avoidance benefits of the trust are lost.

A Living Trust Saves More Taxes Than a Will - False. A living trust is tax neutral compared to a will.

A Living Trust Saves Executor Fees - This depends on how much the trustee (of the living trust) charges for his services. Under state law, a trustee of a living trust is entitled to a “reasonable fee.” There are no guidelines on what is reasonable, and there is no court oversight. That is why trustees occasionally take ridiculous fees and hope nobody will notice. In Oregon, the “automatic” executor fee is 2% of the estate. Court approval is needed for additional fees. This may be a windfall or a bad deal for the executor, depending on how time-consuming and messy the estate administration turns out to be. But at least it is not a blank check.

A Living Trust Saves Legal Fees at Death – Usually true, but the savings is offset by the added legal fees when the trust is established. (The legal fees for a living trust are perhaps twice the amount for a will.) In Oregon and Washington, post-death probate legal fees are not based on a percentage of the estate. Instead, the probate attorney is compensated for actual hours spent. Further, at least in Oregon, the court must pre-approve all probate attorney fees. In conclusion, post-death attorney fees are normally less when there is a living trust, but the difference may not be substantial. And court approval of probate legal fees prevents attorneys from taking advantage of financially naïve clients.

A Living Trust Preserves Privacy of the Decedent’s Finances - This is true, although of modest importance to most clients. Probate filings (which disclose the assets of the estate, values, names and addresses of beneficiaries, etc.) are a public record and can be reviewed by anyone. On the other hand, the administration of a living trust is private. For this reason, high-visibility clients prefer living trusts.

Lawyers Don’t Like Living Trusts Because They Lose Probate Legal Fees – This is seldom true. Except for elderly individuals or those with serious health issues, the probate legal fees are so far down the road that they are all but irrelevant to the attorney. But the attorney does not have to wait for the extra legal fees needed to prepare a living trust.

AVOID OREGON ESTATE TAX WITH LIFETIME GIFTS (But Be Careful)

Posted on December 3, 2011 by David C. Streicher

Oregon’s estate tax laws have a loophole: If you make sufficient gifts during life to reduce your estate below $1M, you will avoid paying any Oregon estate tax at death. For example, if you have $8M of wealth and give away $7M the day before you die, your Oregon estate tax will be zero. [This does not work for federal estate tax purposes because lifetime gifts (in excess of $13,000/person/year) reduce the $5M lifetime exemption dollar-for-dollar.]

But lifetime gifts of appreciated property can have a boomerang effect. By way of background, the recipient of a lifetime gift will have the same cost basis in the item as the party making the gift. Thus, if a parent gives away stock having a value of $100 and a cost basis of $25, the recipient will have $75 of capital gains if the stock is sold for $100. But if the parent holds the stock until death, the recipient’s cost basis is “stepped up” to $100, meaning the shares can be sold for $100 with no gain or loss.

The significance of the cost basis / stepped-up basis discussion is that the Oregon estate tax savings from lifetime gifts may be dwarfed by the extra income taxes (federal and Oregon) owing when the item is sold. Example: A parent makes a lifetime gift of stock having a value of $500,000 and a cost basis of $200,000. Since the Oregon estate tax marginal rate (starting in 2012) is 10%, the gift would save Oregon estate tax of $50,000, i.e., 10% of $500,000. But the recipient’s eventual capital gain (upon sale) will be $300,000 more than if the gift had been made at death. If we assume a combined federal & Oregon capital gains rate of 24%, the extra income tax (when the item is sold) will be about $72,000, which exceeds the $50,000 Oregon estate tax savings. Keep in mind that the Oregon estate tax is due 9 months after death, whereas income tax is not due until the item is sold. Thus, if the recipient is going the hold the shares for a long period of time, the analysis is muddier.

The moral of the story is that a parent should consult a tax professional prior to making huge deathbed gifts as a tax-savings strategy.

FOREIGN ACCOUNT TAX COMPLIANCE ACT (“FATCA”)

Posted on November 29, 2011 by David C. Streicher

Reporting obligations for “offshore” accounts (including RRSP and RRIF accounts in Canada) have been expanded by the Foreign Account Tax Compliance Act (“FATCA”), which is codified at Sections 1471 – 1474 and 6038D of the Internal Revenue Code. Sections 1471 – 1474 apply to “foreign financial institutions,” and Section 6038D applies to US persons having offshore accounts.

While the provisions of Sections 1471 – 1474 are dense, the intent is relatively simple — to compel disclosure of tax information from offshore entities that are not subject to Form 1099 reporting. Otherwise, the IRS has no record of income earned by US persons on these offshore investments. Foreign financial institutions are required to liberally share information about accounts held by US persons and, in some cases, withhold a 30% tax on payments made to US persons who do not cooperate with the IRS. If the foreign financial institution does not comply, there is a 30% withholding tax on payments of certain US source income to the foreign financial institution. In Notice 2011-53, the IRS issued timelines for the implementation of Sections 1471-1474. In general, withholding obligations have been delayed to 2014 and 2015, depending on the type of payment involved.

Effective for tax years beginning after March 18, 2010 (i.e., 2011, for most of us), US persons must report offshore assets directly to the IRS by filing Form 8938, Statement of Specified Foreign Financial Assets. Items reported on Form 3520 (foreign trusts and gifts) or 5471 (foreign corporations) need not be reported on Form 8938. However, taxpayers must include on Form 8938 all items already reported on Treasury Form 90-22.1. Single taxpayers living in the US must file Form 8938 if foreign financial assets exceed $50,000 at year end or $100,000 at any time during the year. These threshold amounts are doubled for married taxpayers living in the US and filing a joint return. If living abroad, the threshold for single taxpayers is $200,000 / $400,000, and the threshold for married taxpayers filing a joint return is $400,000 / $600,000. In general, Form 8938 requires disclosure of “foreign financial assets,” which generally means accounts holding cash or securities maintained by a foreign bank or brokerage house. However, the instructions indicate that interests in foreign mutual funds, foreign hedge funds, foreign private equity funds, foreign corporations, foreign partnerships and foreign trusts are also included. Foreign real estate is not. The penalty for failure to file Form 8938 is $10,000 per year.

In conclusion, now more than ever, it is important for US citizens and residents to file returns as needed to make disclosure of foreign accounts, such as those held through Canadian financial institutions.

IRA PLANNING – MOVING FROM US TO CANADA

Posted on November 27, 2011 by David C. Streicher

A common problem for US citizens or permanent residents moving to Canada is what to do with an IRA account. Additional contributions are not advisable because they would not be deductible in Canada. For Canadian tax purposes, an IRA or 401(k) (but only to the extent of the employee’s contributions) may be rolled over tax free to a RRSP or RRIF. But no tax free rollover is allowed for US tax purposes, meaning that the owner must pay US income taxes (usually a 15% withholding tax) and the Section 72(t) 10% penalty (if the owner is under 59 ½) on the distribution.

A common strategy is to leave the IRA dormant until the owner is ready to take distributions. However, a number of US brokerage houses are unwilling to hold IRA
accounts for citizens or permanent residents of Canada, which may require
transferring the IRA to a more user friendly broker. Even “friendly” US brokers
limit transactions and trades by such Canadian persons.

US-Canadian tax differences warrant careful planning for moves from one country to the other.

RRSPs, RRIFs and TFSAs – CANADIAN COUSINS TO IRAs and 401(K)s

Posted on November 25, 2011 by David C. Streicher

The closest Canadian equivalent to an IRA or 401(k) is the Registered Retirement Savings Plan, which is commonly known as the “RRSP.” Contributions are tax deductible, and tax is payable as distributions are taken, which may occur at any time. The maximum annual RRSP contribution is roughly 18% of earned income, up to a maximum of $22,000 CAD. At age 71, a RRSP must either be distributed or converted into a Registered Retirement Income Fund (or “RRIF”), which has characteristics similar to an RRSP except that no contributions may be made and there are mandatory annual withdrawals. The Canadian equivalent to a Roth IRA is the Tax-Free Savings Account (or “TFSA”). Contributions are not deductible, but distributions (which may be taken at any time) are not taxable.

If a US person living in Canada contributes to an RRSP, a deduction is allowed for Canadian tax purposes, but not for US tax purposes. In the hands of a US citizen or resident, US tax laws treat RRSP or RRIF funds like any other investment not sheltered by a qualified plan: dividends, interest and capital gains are taxed as earned, whether withdrawn or not. Thus, all income earned after moving to the US will be taxed by the US — unless the taxpayer files IRS Form 8891 to defer U.S. tax until distributions are made. The cost basis of an RRSP, RRIF or TFSA (generally comprised of contributions and earnings prior to moving to the US) can be withdrawn free of US tax. The taxable-nontaxable computations are tedious. The Form 8891 election also defers Oregon income tax in a like manner.

Next post – IRA planning when moving from US to Canada

IRA TAX PLANNING – TRUST OR ESTATE AS BENEFICIARY

Posted on November 23, 2011 by David C. Streicher

Navigating the tax complexities of naming a trust or estate as IRA beneficiary is not for the faint of heart.

Inherited IRAs and Required Minimum Distribution Rules

A couple of background rules are helpful. The IRA beneficiary designation identifies who receives the balance of the decedent’s IRA (commonly known as an “inherited IRA”) at death. If a spouse is named as beneficiary, she or he can roll over the IRA into the spouse’s own IRA and then designate a new set of beneficiaries. See Treasury Regulation § 1.408-8, A-5(a). If an individual other than a spouse is named as beneficiary, the individual may stagger distributions of the inherited IRA over the individual’s life expectancy, based on tables provided by the IRS. See Code Sections 401(a)(9) and 408(a)(6). This is often referred to as a “stretch IRA.” The minimum amount that must be withdrawn each year is known as the “required minimum distribution,” or RMD. (The beneficiary can always take more than the RMD, but not less.) Example: The life expectancy for a 60 year-old beneficiary is 25.2 years. This means the individual must take a RMD from the inherited IRA of roughly 1/25th of the IRA in Year 1, 1/24th in Year 2, 1/23rd in Year 3, etc., until the individual’s death. The owner of the inherited IRA on the records of the custodian will be “John Smith, deceased, for the benefit of Robert Smith.”

If a Trust is Beneficiary

If a trust is named as beneficiary, the same “stretch IRA” benefits are available so long as an individual is the beneficiary of the trust. See Treasury Regulation § 1.401(a)(9)-4, A-5(b)(3). The RMD is based on the beneficiary’s life expectancy. The owner of the inherited IRA on the records of the custodian will be “John Smith, deceased, for the benefit of James Johnson, Trustee of the Robert Smith Trust.” Mechanically, however, the arrangement is awkward. In order to qualify for “stretch IRA” treatment, the trust agreement must require the trustee to distribute to the beneficiary no less than the RMD each year. In other words, the trustee cannot accumulate any of the RMD; if he does, there is a penalty equal to 50% of the accumulation. See Code Section 4974(a). Another burden is that the trust must to file federal and state income tax returns each year, whereas this is unnecessary if an individual is the named beneficiary. Finally, what happens when the beneficiary reaches the specified age (21, 25, 30, etc.) and the trust terminates? The tax laws allow the trustee to assign its beneficial interest in the inherited IRA to the beneficiary without accelerating the embedded income. See Treasury Regulation § 1.691(a)-4(b)(3). This means the IRA remains intact and the only change is that there is a new designated beneficiary. (Note: this is different than distributing the IRA and paying the proceeds to the beneficiary.) However, more often than not, the IRA custodian will flatly refuse to name the individual as the new beneficiary. Instead, the custodian will insist that the trustee make a taxable distribution of the entire IRA, and pay the proceeds to the beneficiary. From a custodian’s perspective, creative solutions mean extra work generating no fees, so there is no motivation to accommodate them. From a tax perspective, a taxable distribution is a disaster since it accelerates income that might otherwise be deferred for decades. Also, the bunching of income in a single year may capture the highest marginal tax rates. If the IRA custodian will not cooperate, the trustee’s only alternative is to move the funds to a more user friendly IRA custodian. In my experience, Vanguard and Fidelity are reasonably cooperative on these types of requests.

If Estate is Beneficiary

What if the “estate” is the designated beneficiary? This is usually the worst of all worlds, and typically occurs when the owner fails to designate any beneficiary and the “estate” is the default beneficiary under the account agreement. In general, if the decedent was over 70 1/2, the inherited IRA must be distributed to the estate over the decedent’s remaining life expectancy. See Treasury Regulation § 1.401(a)(9)-5, A-5(a)(2). (The estate will pay the tax on each IRA distribution, and the funds remaining will be paid to the beneficiaries under the will.) This is dysfunctional. If the decedent is elderly, the IRA must be distributed over a relatively short period. A bigger problem is that it is usually impracticable to continue a probate proceeding for 5, 10 or 15 years. Courts will try to force the executor to close the estate and get the case off the docket. Further, keeping the estate open causes ongoing filing fees, attorney and accounting fees. Thus, the executor will be tempted (or forced by the court) to withdraw the entire IRA at once, thereby ensuring it is subject to the maximum amount of tax. There is at least one partial fix. Instead of withdrawing the IRA in a taxable distribution, the executor can assign the estate’s beneficial interest in the IRA to the beneficiaries under the will. As in the trust example above, the inherited IRA will remain intact and individuals will be substituted in place of the estate as the new beneficiaries. See, e.g., Private Letter Ruling 2005-20004. The new beneficiaries will be relegated to withdrawing the IRA over the decedent’s remaining life expectancy, but this is almost always better than the alternative. (For example, the life expectancy of an 80 year-old individual is 10.2 years.) The trick is to get the custodian to cooperate, which is usually an uphill battle.

In conclusion, an abundance of caution should be exercised when naming a trust (or worse yet, an estate) as IRA beneficiary. If you find yourself charged with administering an IRA for which a trust or estate is the named beneficiary, there is no substitute for an experienced lawyer.

WHEN TO NAME A TRUST AS IRA BENEFICIARY (Part 1 – Non-Tax Issues)

Posted on November 17, 2011 by David C. Streicher

In limited circumstances it is prudent to name a trust as IRA beneficiary. The practice should be used sparingly, however, because it adds a layer of complexity and increases the administrative burden.

When a Trust Makes Sense:

Young Children – If the IRA owner has young children, the share allocable to them should pass to a trust. The beneficiary designation should state that a child will be a “direct” beneficiary if he or she has reached a specified age, and if not, a trust for the benefit of the child will be the beneficiary. For example, the beneficiary designation might state: “The balance in my IRA shall pass to my children in equal shares, with the surviving lineal descendants of a deceased child of mine to take by right of representation the share the deceased child would have received if then living; provided, however, that if any amount is allocable to a person then under ____ years of age, such portion shall be held by the trustee under my will as a separate trust for the benefit of such person pursuant to Article ___ thereof.”

Individual with Developmental Disabilities, Substance Abuse or Extreme Irresponsibility – A trust should be named as beneficiary for individuals in these categories.

Spouse of Second Marriage – Without a trust, a surviving spouse is able to designate the new contingent beneficiaries to take at the spouse’s death. In a second marriage, this might be the spouse’s children, to the exclusion of the children of the first spouse to die. At least theoretically, a trust solves this problem if it (i) relegates the spouse to support related distributions, and (ii) allocates the remaining balance at the spouse’s death to the desired individuals. But who will serve as trustee? If the spouse is trustee, no one may know if the spouse takes excessive distributions. The Oregon Uniform Trust Code requires a trustee to provide reports to remainder beneficiaries, but the spouse may decline to do so and gamble that the decedent’s children will not press the issue. On the other hand, if a child of the decedent is the trustee, friction is inevitable because the spouse will not want to ask (or beg) a stepchild for distributions.

Beneficiary Designation Would be Too Complicated – A client’s will is occasionally so complicated with multiple beneficiaries, fractional shares, formulas, conditional gifts, etc., that a consistent IRA beneficiary designation is certain to be rejected by the IRA custodian. If so, a pragmatic choice might be to designate the client’s estate or revocable trust as beneficiary. While this is conveniently simplifies the name of the beneficiary, it raises numerous tax and administrative issues that will be covered in the next post.

NEXT POST: Tax issues when naming a trust or estate as IRA beneficiary

AVOIDING PROBATE (Part 2) – TAX ISSUES

Posted on November 15, 2011 by David C. Streicher

Should we avoid probate at all costs? The short answer is no; panicked efforts to transfer assets to avoid probate frequently cause more harm than good. Here are some examples:

1. Tax Disadvantages of Giving Away Appreciated Assets – Children often convince a parent to transfer the family home to them as a strategy for avoiding probate. The problem is that the cost basis of the house in the hands of the children is the same as that of the parent — which is probably very low. Thus, the children will pay capital gains tax on the appreciation when they sell the house. On the other hand, if the house is transferred at death, the children’s cost basis increases to the fair market value at death. Thus, they can then sell house with no gain or loss. The same rule applies to appreciated stocks and bonds.

2. Estate Plan Distortions from Joint Accounts – The “dirty little secret” of a joint account is that it passes to the surviving owner. If the survivor is one of several siblings, and refuses to split the funds after the parent’s death, there will be lively discussions or bitter lawsuits. This unfortunate circumstance commonly occurs when a child suggests using a joint account to facilitate “helping” the parent with paying bills, etc. After the parent dies, the child often contends that the balance in the account was intended to pass to him or her as compensation for taking care of the parent. Another nuance of joint accounts is that any party can withdraw the entire account at any time. What if a child disagrees with the parent’s expenditures, and withdraws the entire account to take control?

3. Losing Control – What if the parent gives the home to the children to avoid probate, and the children then decide to sell the home (and force the parent to move to a retirement center) against the parent’s wishes? Before giving away assets, the parent should assume that the gifts cannot be recovered, and that the children will have absolute control.

4. Medicaid Disqualification – There are harsh rules preventing a parent from expediting eligibility for Medicaid by giving away assets. To the contrary, giving away assets may well disqualify the parent from Medicaid.

Proceed cautiously (i.e., slowly) before transferring assets to avoid probate. A living trust (also referred to as a “revocable trust”) will usually avoid probate without any of the pitfalls described above.

AVOIDING PROBATE (Part 1)

Posted on November 14, 2011 by David C. Streicher

So you want to avoid probate? If “yes,” it is worthwhile to describe what you are avoiding.

Probate is the court supervised procedure for settling the decedent’s liabilities, determining who is entitled to the decedent’s property, and making the transfers. Mechanically, probate is effectuated through roughly a dozen filings with the court over a period ranging from six months to two years.

A probate proceeding is initiated by filing the decedent’s original will along with a petition asking the judge to appoint as executor the individual nominated in the will. A filing fee of $500 – $750 is due at that time. The court usually appoints the nominee. The executor then files an inventory of the decedent’s money and property, and gives notice to creditors and interested parties. A new bank account is established, and all receipts and disbursement for the duration of the probate are run through this account. After all executor tasks are completed (including selling assets, paying bills and filing tax returns), he or she files a petition asking the judge for permission to make a final distribution. The petition contains an accounting of every receipt and disbursement that reconciles with the final balances on hand. Normally, the judge approves this request and the executor distributes the property of the estate to the persons named in the will. The executor then files receipts and is discharged. A lawyer typically prepares the various filings with the court, and coaches the executor to ensure that all legal duties are fulfilled. Probate attorney fees can run anywhere from $3,000 to many times that amount, depending on the number of extraordinary tasks for which the executor needs legal counsel.

For Washington estates, a streamlined “nonintervention” procedure is available, which reduces court filings by roughly one half. The filing fee is also reduced by about one half.

WILL CONTESTS

Posted on November 10, 2011 by David C. Streicher

Estate litigation occurs with increasing frequency. Perhaps the most frequent challenge (known as a “will contest”) is a suit alleging that the will is invalid because the signer had inadequate mental capacity or was under the influence of others. In practice, only wills of sick or elderly individuals are challenged.

The decedent’s death certificate is often a useful starting point in evaluating mental capacity. For example, the death certificate will indicate if Alzheimer’s or dementia was the cause of death, and the interval between the onset of the disease and death. If the decedent had Alzheimer’s for three years prior to death, a will signed six months before death is vulnerable. The requisite mental capacity to sign a will is not a high standard: the signer must know his family members, have some idea of the extent of his wealth, understand that he is signing a will that disposes of his property at death, and have a general understanding of how the will disposes of his property.

Even if the signer had sufficient mental capacity, the will might be thrown out because the signer was subjected to “undue influence.” A typical fact pattern is that a child with a position of dominance successfully pressures an elderly or sick parent to sign a new will that reduces the amounts passing to the child’s siblings or other relatives. Factors suggesting undue influence include:

1. The benefitted child initiated the preparation and signing of the new will by contacting a lawyer, providing the lawyer instructions on the desired will provisions, and driving the signer to and from the lawyer’s office.

2. The signer had little or no contact with the lawyer out of the presence of the child initiating the process.

3. The will was executed in haste and concealed from the child’s siblings and relatives.

4. The signer made an abrupt change in the will by adding beneficiaries outside the family (such as a caregiver or romantic attraction) or cutting out family members. For example, have the signer’s wills consistently treated the children equally, until the last will disinherited one of the signer’s two children?

Before challenging a will, you should determine whether it has a “no contest” clause. Such a clause frequently states that a person challenging the will is treated as if he or she predeceased the signer and was not survived by descendants. This cuts out the share otherwise passing to the challenger and his children, and commensurately increases the shares passing to the other beneficiaries.

As you might expect, will contests are messy, costly and contentious. The outcome will be based on bits and pieces of evidence ranging from doctor’s reports (if there are any), testimony of countless witnesses who knew the decedent, and examination of documents signed by the decedent. It is usually an understatement that there is no love lost between the parties, which tends to frustrate settlement of the case in a businesslike manner.

If a sick or elderly person plans to sign a new will that significantly changes the estate plan, it is usually possible to preserve or create evidence that the signer had sufficient mental capacity and was not unduly influenced by others. Conversely, if you are examining the circumstances of a will after the signer’s death, a trained eye can usually identify suspicious facts and advise you of the deadline for filing suit. In all events, you should hire an experienced estate planning lawyer who can efficiently navigate you through the process.

HOW MUCH IS WASHINGTON’S ESTATE TAX?

Posted on November 8, 2011 by David C. Streicher

The big difference between Oregon and Washington is that Oregon’s estate tax covers all wealth in excess of $1M, while Washington’s tax only applies to wealth in excess of $2M. In the table below, I have summarized the Washington tax payable on estates of various sizes. The stated value of the estate is net of deductions for items or amounts passing to the surviving spouse or charity.

If the net estate is less than $2M, tax is zero
If the net estate is $2.5M, tax is $50,000
If the net estate is $3M, tax is $100,000
If the net estate is $3.5M, tax is $170,000
If the net estate is $4M, tax is $240,000

Washington’s marginal estate tax rate is only 10% on the $1M layer of wealth between $2M and $3M. Then it jumps up to 14% for the excess over $3M, then 15% for the excess over $4M, etc.

Washington’s estate tax can be reduced or eliminated through careful planning with an experienced estate tax attorney.

HOW MUCH IS THE OREGON ESTATE TAX?

Posted on November 7, 2011 by David C. Streicher

How much is the Oregon estate tax bill?

Oregon estate taxes are computed on Form IT-1. If a federal Form 706 must also be filed, it must be attached to the Oregon Form IT-1. Here’s a sampling of the Oregon estate tax for persons who die in 2011. The tax is a percentage of the decedent’s “taxable estate,” which is the excess of all of the decedent’s wealth over items or amounts passing to the surviving spouse or charity. For example, if the decedent’s wealth is $1.3M and $1M passes to the surivivng spouse, the taxable estate is $300,000.

Taxable estate is $1M or less, the tax is zero.
Taxable estate is $1.1M or less, the tax is $38,800.
Taxable estate is $1.5M or less, the tax is $64,400.
Taxable estate is $2M or less, the tax is $99,600.
Taxable estate is $3M or less, the tax is $182,000.

As you can see, the $100,000 layer of wealth between $1M and $1.1M gets taxed at the prohibitive rate of 38.8%. But with careful planning, the Oregon estate tax can usually be reduced or eliminated.

PS – Next post is the Washington estate tax

FINE-TUNE YOUR IRA BENEFICIARY DESIGNATIONS…….

Posted on November 4, 2011 by David C. Streicher

IRA beneficiary designations are commonly overlooked, but incredibly important. In general, a will does not affect the destination of IRA monies at death; instead, the beneficiary designation controls.

For whatever reason, many clients either don’t designate a beneficiary or forget to name a contingent beneficiary. If you don’t designation any beneficiary, the “default” beneficiary is normally the decedent’s estate, which is unfortunate. Absent creative maneuvering after death, the tax on the IRA will be accelerated when it is distributed to the estate. Had an individual been named, the individual could have withdrawn funds over his or her life expectancy, thus obtaining “stretch IRA” benefits.

If you name a primary beneficiary (usually your spouse), but no contingent beneficiary, the estate will once again become the default beneficiary if your spouse predeceases you. Thus, you should name your children, grandchildren, etc. as contingent beneficiaries. There is more. You need to specify what happens if a child of yours predeceases you. Do the siblings take the child’s share? Or do the child’s descendants receive the share? And what happens if one or more of the descendants are under 18, 21, or whatever age you think is appropriate for having responsibility over the funds? You may need to specify that a trust is the beneficiary if this occurs.

Finally, IRA custodians occasionally lose the beneficiary designation. So it makes sense to either check your IRA beneficiary designation from time to time, or just fill out a new form every five or ten years. Don’t rely on your recollection that you filled out a beneficiary designation 20 years ago….

If your IRA is substantial, it pays to get professional advice in designating beneficiaries.

PS – Is your former spouse still named as beneficiary?

WHEN TO NAME A BANK AS EXECUTOR

Posted on November 3, 2011 by David C. Streicher

Although banks were commonly named as executors many years ago, this is seldom true anymore. But it certain cases, it still makes sense.

If your children have issues with each other, the child named as executor will have a thankless job. The child’s siblings will be miffed that they were not appointed executor. They will continually contend the executor is acting out of self-interest or favors some siblings at the expense of others. Tasks as insignificant as dividing the decedent’s personal property may turn into a war. Every action the executor takes will be questioned or opposed by at least one sibling. By the time the estate is closed, your children will be so frustrated with each other that family gatherings may be a ritual of the past. In general, your family is better served if they are mad at a bank rather than each other. Thus, if your children are or might turn hostile, using a bank is money well spent. Keep in mind that children are usually on their best behavior while one or both parents are living. The bottled up resentments usually surface after both parents are deceased.

A bank is also good choice if all of the children have serious problems (mental illness, health, substance abuse, developmental disabilities, gambling, incarceration, terrible judgment, etc.) or live too far away to effectively manage the estate. While you can always nominate an uncle, aunt, cousin, nephew or niece, the executor fee is usually insufficient to inspire enthusiasm to intervene in another family’s matters. Further, if the decedent has no close family, a bank makes sense.

Another advantage to a bank is that the trust officers seldom make serious mistakes. They have experience administering estates. They are aware of the deadlines. They know the potential problem areas and how to avoid them. The executor fee to a bank is no different than that payable to anyone else — roughly 2% of the estate. A relative might waive the fee, but you will probably get what you pay for.

In conclusion, while everyone (including me) has a horror story about a bank, there are many scenarios in which a bank is absolutely the best choice for serving as executor. You may end up saving your family enormous trauma and legal fees by naming a bank as executor.

WHO SHOULD I NAME AS EXECUTOR?

Posted on November 1, 2011 by David C. Streicher

Choice of executor (sometimes known as “personal representative”) can be the most important part of your will.

In general, most married couples name the surviving spouse as executor. The more difficult choice is the executor upon the death of the surviving spouse. In a harmonious family, one or more of the children is usually a prudent choice. Which one? All things being equal, a child living nearby is a better choice than one living 1,000 miles away. The child you select should be responsible, respected by the siblings, fair, and (above all) endowed with common sense. Ability and willingness to communicate with siblings is also a plus. Never name a child who is undependable, sloppy or indifferent. It is not necessary to select a child with legal, accounting or investment management skills; a prudent executor will hire professionals to provide these services.

A common approach is to name two or more children as co-executors, which treats everyone equally, but presents logistical challenges in getting documents signed and making decisions. Occasionally, I name co-executors but add language encouraging some of the children to decline to serve, thereby streamlining administration. This avoids any sting of favoritism. Many clients simply name their children in order of birth. Although not especially logical, this avoids favoritism without adding the administrative burden of co-executors. Finally, many parents are willing to name individual children “out of order.” Usually the children recognize there is good reason why some of them are skipped. But they will also recognize (and resent) instances when a controlling sibling arm-twists the parent into favoring him or her over the others.

In my next post, I will discuss when it makes sense to hire a bank as executor or trustee.

DISADVANTAGES OF LIVING TRUSTS (Part 3) – BEWARE OF THE THREE RING BINDER

Posted on October 27, 2011 by David C. Streicher

I frequently meet clients whose living trust is a 50+ page agreement mounted in a padded red or green three-ring binder containing 150 pages or more. Although there are exceptions, many of these packages are generated through a one-size-fits-all template distributed through a national vendor. Typically, 1/3 to 1/2 of the pages are irrelevant to the client’s particular circumstances. Sifting through countless pages to glean the essence of the plan is frustrating and unnecessary.

Every client deserves a customized trust agreement. If your agreement is more than 20 single-spaced pages, it is probably bloated with irrelevant material. There are perhaps four key sections to a trust, namely (1) designation of trustees (and successor trustees), (2) allocations to minimize estate taxes, (3) apportionment of taxes among beneficiaries, and (4) the ultimate disposition of wealth at death. These topics should be readily identifiable without digging through dozens of pages.

If your trust agreement is incomprehensible to you, it may also be incomprehensible to those who will ultimately administer your affairs. Shorter is better.

DISADVANTAGES OF LIVING TRUSTS (Part 2) – THE TYRANT TRUSTEE

Posted on October 25, 2011 by David C. Streicher

A seldom-mentioned downside to living trusts is the trustee’s lack of accountability to any court. Usually this is a good feature, and saves time and money for everyone. But not always.

Court oversight serves no purpose when the parents are the trustees, since it is their money and they should not be accountable to anyone. But it can be a big deal when a child becomes successor trustee, whether before or after the death of the last surviving parent.

For whatever reason, the successor trustee is seldom transparent in sharing information with the other beneficiaries, who are usually siblings. Human nature being what it is, the beneficiaries assume the worst, i.e., that there is a reason the trustee is keeping them in the dark. For example, since not required by the Oregon Uniform Trust Code, the trustee may feel there is no need to prepare or circulate an inventory of what is on hand. Unless prodded, the trustee may also decline to provide an accounting of receipts and disbursements. The trustee may take excessive trustee fees or pay personal expenses from the trust. The court does not police these items.

It is true the beneficiaries have limited rights under the Uniform Trust Code to file suit to obtain information, etc., but they must hire an attorney to do so. In a probate (or a conservatorship), the executor is required by law to share information, and must secure court approval prior to taking executor fees.

Beware of the rogue successor trustee when using a revocable trust.

DISADVANTAGES OF LIVING TRUSTS (Part 1) – FUTILITY OF THE UNFUNDED TRUST

Posted on October 24, 2011 by David C. Streicher

Living trusts (also known as revocable trusts) are will substitutes that are frequently promoted as an “avoid probate” panacea everyone should have. As in TV commercials for medications, however, I need to share several unfavorable “side effects.”

I routinely administer living trusts after death, and at least one-third of them are not fully funded. In other words, some of the decedent’s property was not transferred to the trust during life. This means we have to do a full probate, the avoidance of which is the key reason for establishing a living trust in the first place. Equally important, it means a waste of the client’s time and money setting up the trust.

In the next few posts I will cover additional drawbacks that often tilt the scales against using a living trust.

WHAT IS A TRUST?

Posted on October 21, 2011 by David C. Streicher

Is a trust the same as a corporation, LLC or partnership? No!! It’s a completely different animal.

A trust is merely a contract between two parties. One party to the contract transfers property to the other, who is known as the “trustee.” The written trust agreement spells out what the trustee is supposed to do with the property. The trust agreement should also contain a slate of successor trustees who will serve if the original trustee resigns or is unable to serve.

For example, I might transfer $1,000 to my wife, as trustee, pursuant to an agreement stating that she is to manage and distribute the funds for the benefit of my child until he reaches 21. Or, if I am setting up my own “living trust” or “revocable trust,” I might transfer property to myself, as trustee, pursuant to a trust agreement with instructions on how the trustee should manage and distribute the property for my benefit during my life, and to my family members after my death.

As the name suggests, don’t choose a trustee you don’t trust…..

“PORTABILITY” OF $5M FEDERAL ESTATE TAX EXCLUSION

Posted on October 20, 2011 by David C. Streicher

Each spouse’s $5 million federal estate tax exclusion is now “portable,” meaning that the portion of the exemption not used by the first spouse to die is added to the exclusion of the surviving spouse. See Internal Revenue Code Section 2010(c) and IRS Notice 2011-82. Thus, for example, if all of the decedent’s wealth passes to the surviving spouse, the surviving spouse’s exclusion at death will be $10 million, rather than just $5 million. With only modest planning, a married couple can now pass $10 million of wealth to their children without any federal estate tax.

But portability is allowed only if the executor files IRS Form 706 (the federal estate tax return) within 9 months after the decedent’s death. (Or within 15 months, if the executor files Form 4768 and the IRS approves an extension.) Filing a timely Form 706 is critical; if the executor the misses the deadline there is no portability.

An executor will need to hire a lawyer or CPA to prepare the Form 706, which is lengthy and complicated. If the decedent owns real estate or business interests, appraisals will add to the cost. Spending the money to elect portability (by filing Form 706) makes sense if the surviving spouse’s estate is otherwise likely to exceed $5 million at death. Thus, the executor must look into a crystal ball and guess what the survivor’s wealth may be 3, 5, 10 or 20 years down the road.

Now, more than ever, a decedent’s heirs should consult an attorney experienced in federal estate tax laws.

PS – Neither Oregon nor Washington has adopted portability.

THE MYTH OF GIFT TAXES

Posted on October 19, 2011 by David C. Streicher

Will you owe gift tax if you make gifts exceeding $13,000 per year? For 99% of the population, the answer is never.

Federal gift taxes are computed and reported on Form 709. Under present federal tax laws, gift taxes are payable only if the cumulative amount of your lifetime gifts (excluding those not exceeding $13,000 per year) exceeds $5 million. Gifts not exceeding $13,000 per year per person don’t count in determining if you have used up your $5 million exemption. For example, you would have to give an individual an annual gift of $113,000 per year for 50 years to use up your $5 million exemption. Further, you could give $13,000 per year to 1,000 people, and you would not use up any of your $5 million exemption

It is true you are required to file Form 709 with the IRS for each year during which you make one or more gifts in excess of $13,000 per person. This is an informational return (that allows the IRS to keep track of your gifts over $13,000); no tax is due unless you have used up your $5 million exemption.

Neither Oregon nor Washington has a gift tax, or any equivalent to federal Form 709. Thus, you can make unlimited gifts during life without state gift tax exposure.

Before you work yourself into a frazzle about having to pay gift tax, you should visit an experienced estate planning attorney with a working knowledge of the gift tax and estate tax laws.

WILL vs. IRA BENEFICIARY DESIGNATION: WHO WINS?

Posted on October 18, 2011 by David C. Streicher

IRAs, 401(k)s and retirement plan benefits are frequently the most valuable assets we own. A common assumption is that signing a will takes care of these items. It doesn’t.

A will does not affect items passing by beneficiary designations, such as your IRA or 401(k) accounts. (Nor does a will affect most joint accounts, jointly owned real property, annuities and anything having a transfer-on-death beneficiary.) Thus, your IRA will pass to the persons named on your beneficiary designation even if your will states otherwise. Some would say that the beneficiary designation “trumps” the will. Only if “my estate” is the designated beneficiary does a will control the disposition of an IRA.

The will / beneficiary designation conflict is especially graphic in a second marriage situation. The decedent’s children are relieved when they confirm that the decedent’s will leaves everything to them, as was promised. But it will be hard to overstate their disappointment if the surviving spouse stepparent is the designated IRA beneficiary.

Thus, drafting a will is only the first step in completing an estate plan. Always, always, always, coordinate the beneficiary designations with the will.

PROBATE LEGAL FEES – WASHINGTON

Posted on October 13, 2011 by David C. Streicher

Washington probate laws affecting attorney fees are similar to those in Oregon; they are based on the number of attorney hours devoted to the project. But there are important differences.

Unlike Oregon, Washington attorney fees may be paid as incurred, without prior approval of the court or interested parties. (This assumes the estate is administered without court intervention, which is usually the case.) This chills the ability of interested parties to object. The executor does not have to disclose the attorney fees with a court filing until the probate is concluded. Thus, interested parties will not learn the amount of attorney fees until after they are paid. They can still object within 30 days after the executor sends notification that administration is concluded, but recovering excess fees at that time may be difficult because the estate is already distributed. See RCW 11.68.110(2).

EXCESSIVE PROBATE LEGAL FEES (IN OREGON)?

Posted on October 11, 2011 by David C. Streicher

A common probate complaint is the attorney fee. In Oregon, legal fees are based on the number of hours spent and the lawyer’s hourly rate, not a fixed percentage of the estate. (In comparison, California probate lawyers automatically receive a fee of roughly 2% of the estate, along with additional compensation for extraordinary services.) If the lawyer is experienced and efficient (and ethical), an hourly rate is usually better for the client.

As a safeguard to beneficiaries of Oregon estates, all legal fees must be approved by the court. The lawyer must file with the court and interested parties (1) a narrative describing the unique challenges in the probate, and (2) a bill itemizing the hours spent and tasks performed each day. Any interested party who feels the fee is excessive can file an objection and speak to the judge at a hearing. Only those fees approved by the judge may be paid to the lawyer. This is an advantage of probate. If the decedent’s wealth passes free of probate under a living trust, there is no outside oversight over legal fees or trustee fees.

In general, the fee might be as low as $2,500 for a simple probate with cooperative executors and beneficiaries. But almost every estate has complications. For example, the lawyer may have to deal with an executor’s sloppy recordkeeping, fights over personal property, ongoing delays (caused by troublesome beneficiaries or a plodding executor), cash shortages, estate tax returns, disputes among heirs, hard-to-sell assets, or creditor claims.

Do you want to save legal fees? Appoint a responsible executor and hire an experienced lawyer.

EXECUTOR FEES

Posted on October 4, 2011 by David C. Streicher

How much does one receive for serving as executor?

In Oregon, the base executor fee is roughly 2% of the value of assets passing under the will, and roughly 1% of assets passing outside the will. See Oregon Revised Statute 116.173. For example, if the decedent owned a $1 million home (which passes under the will) and $700,000 of IRAs and life insurance (which pass outside the will), the fee would be roughly $27,000. The fee is not reduced by the decedent’s debts or mortgages. If the executor performs extraordinary services, additional compensation can be requested. The executor fee is not always commensurate with the amount of work involved. For example, very little work is involved in administering the estate of an elderly individual whose only asset is a $1 million brokerage account. On the other hand, countless hours might be needed to administer a $200,000 estate involving numerous creditors, delinquent tax returns, insufficient cash, hard-to-sell real estate, substantial clean up work, beneficiary disputes, etc.

Washington’s executor fee is not a fixed percentage. Instead, the executor is entitled to a “reasonable” fee. In general, reasonableness for an executor fee is based on the same criteria as attorney fees, including time required, difficulty, requisite skill, amount customarily charged in that community, size of estate, experience, etc. See RCW 11.68.100(2) and Rule of Professional Conduct 1.5(a).

DID GETTING MARRIED (IN WASHINGTON) REVOKE MY WILL?

Posted on October 3, 2011 by David C. Streicher

In Washington, marriage does not revoke a pre-marriage will, although the end result is similar. Unless the pre-marriage will names the spouse and confers more than a nominal gift, the omission of the spouse is presumed to be unintentional. As a result, absent clear and convincing evidence of the decedent’s contrary intent, the spouse will receive the same inheritance as if the decedent died without a will. This means that the spouse will receive all of the decedent’s community property and at least half of the decedent’s separate property. See Revised Code of Washington 11.12.095. For marriages later in life, this is seldom the intended result.

If a pre-marriage will does not name and provide for the spouse, the executor can preserve the will only by providing clear and convincing evidence that the decedent intended the spouse to receive nothing under the will. In determining the decedent’s intent, the court will consider community property agreements, the decedent’s will, prenuptial agreements, and gifts passing to the spouse outside of the will. For example, a Washington court recently held that designating the spouse as an 80% beneficiary of the decedent’s IRA was sufficient to show that the decedent intended the spouse to receive nothing under the will. See Bay v. Estate of Bay, 105 P3d 434 (Washington Court of Appeals, 2005).

The cost of litigating a probate dispute about a decedent’s intent is enormous. But one can easily avoid this mess by consulting an estate planning lawyer prior to marrying.

DID GETTING MARRIED (IN OREGON) REVOKE MY WILL?

Posted on September 29, 2011 by David C. Streicher

A little-known secret for Oregon residents is that your will is revoked when you marry. As a consequence, your property passes as if you had no will. If you have children from a prior marriage, your estate will be evenly divided between your children and your spouse. And if you have no children, your spouse will receive everything. This is usually a huge shock to children, grandchildren, nieces, nephews, charities, etc. that are named as beneficiaries under your will.

Several exceptions soften the general rule. First, the will is not revoked if it specifically states that it is not revoked by marriage (which few wills do). Second, the will is not revoked if it was prepared in contemplation of marriage. Finally, the will is not revoked if the parties entered into a prenuptial agreement. See Oregon Revised Statute 112.305.

Especially for those marrying later in life (or on a second marriage), it makes sense to visit a lawyer before marriage and determine what is necessary to ensure your wealth passes in the desired manner.

Washington has a similar law, which I will cover in the next post. See RCW 11.12.095.