Author: Hal R. Terr, CPA, PFS, CFP®, AEP®, Partner
While many high net worth individuals like the concept of utilizing their current lifetime gift exemptions, most of these individuals are concerned that the loss of access to income and principal of the gifted property may negatively impact their retirement lifestyle. A Spousal Lifetime Access Trust (SLAT) can provide the grantor’s spouse with limited accessibility during the spouse’s lifetime while keeping the assets out of both the grantor’s and spouse’s taxable estates.
The SLAT must be irrevocable and the grantor must not have any incidents of ownership in the trust property. A properly drafted SLAT should not grant any beneficial interest to the grantor or give the grantor any power to replace the trustee with himself/herself. The grantor would make gifts to a lifetime credit shelter trust for the benefit of the grantor’s spouse and possibly children. The trust would be designed to give as much control and flexibility to the surviving spouse as desired without creating tax or creditor concerns. Some high net worth individuals may want to go further and have each spouse create a SLAT for the other spouse. Care must be taken so that the trusts are structured to avoid the reciprocal trust doctrine and therefore avoid estate inclusion in both spouse’s estates.
Jim and Mary create irrevocable trusts for the benefit of the other spouse for the remainder of their lives and thereafter for their children and grandchildren. Jim and Mary authorize their estate attorney to prepare the trusts and understand that the plan, in effect, accelerates the credit shelter trust for each other that are provided for at death under their current estate planning documents. Jim and Mary fund each trust with cash and marketable securities of $5.12 million each. Jim may receive from the trust Mary establishes for his benefit income and principal for his health, support and maintenance. Mary can receive from the trust Jim establishes for her benefit income annually and she and the children can receive principal from the trust based on trustee’s discretion. Under these SLATs, Jim and Mary, while both alive, still have access to the amounts gifted to the trusts but it is outside of their taxable estates. Jim and Mary will each allocate $5.12 million of gift and generation skipping transfer tax exemption on their 2012 gift tax returns so that these trusts would be excluded from their estates and would also avoid inclusion in their children’s estates.
Besides the risk of estate inclusion due to reciprocal trust doctrine, there are other risks high net worth individuals should consider before funding SLATs. Recipients of gifts receive the grantor’s basis in the gifted asset, as opposed to a basis equal to the fair market value at the date of death for inherited property from a decedent’s estate. If there is significant appreciation in the gifted property, the donee will have long term capital gain exposure when the property is sold. The current long-term capital gains rate on marketable securities is 15%, but this rate is scheduled to lapse on January 1, 2013 and return to 20%. In addition, there is a potential risk of claw back if the estate tax exemption at the time of death is less than the current $5.12 million exemption. If the estate tax exemption is less than the amount of exemption utilized by the grantor during their lifetime, the excess may be brought back into the grantor’s estate and be taxed at the estate tax rate in effect at that time. Most commentators do not believe claw back was intended by Congress when the original legislation was enacted and maybe grandfathered if any reduction in the estate exemption occurs, however, the risk still remains. Even in the unlikely event the claw back applies; making lifetime gifts is still beneficial because the appreciation in the assets gifted is removed from the grantor’s estate. While many states have an estate tax, most states do not have a gift tax. By making lifetime gifts high net worth individuals can avoid future state estate taxes for the amounts transferred during their lifetime.
With some estate tax law provisions expiring after 2012 and the uncertainty over what actions Congress will take regarding estate tax law, you may have concerns about how your estate plan could be affected. We would be pleased to work with you and your estate planning attorney to ensure that your estate plan takes full advantage of the higher gift exemptions this year and has the flexibility required to manage future estate tax law changes.
Barry H. Horowitz, CPA, MST, Partner & Hal R. Terr, CPA, PFS, CFP®, AEP®, Partner
The Economic Growth and Tax Relief Reconciliation Act of 2001 changed the credit for state estate taxes paid to a deduction on the federal estate tax return. In response to this change, states like New Jersey and New York made changes to their state estate taxes. Although the federal estate tax exemption is currently $5.12 million, the exemption for New Jersey and New York estate taxes is $675,000 and $1 million, respectively. Therefore, residents of New Jersey and New York who might not be impacted by the federal estate tax due to the increases in the federal estate exemption may still incur a state estate tax liability. Conversely, as long as state estate taxes are only a deduction on the federal estate tax return, residents of Florida are not subject to state estate taxes. Florida had a “pick-up tax” based on the state estate tax credit that the IRS previously allowed on the federal estate tax return. Unless Congress intervenes, then the Florida estate tax will return for Florida residents dying on or after January 1, 2013.
Following is a comparison of states current estate tax laws:
|NEW JERSEY||NEW YORK||PENNSYLVANIA||FLORIDA|
|Does State Have an Estate Tax?||Yes||Yes||No||No|
|Does State Have an Inheritance Tax?||Yes||No||Yes||No|
|Highest Tax Rate||16%||16%||15%||N/A|
States generally use two definitions in determining the residency status of a resident individual. An individual may be a resident for personal income tax purposes, and taxable as a resident, even though that same individual would not be deemed a resident for other tax purposes.
Some states, such as California, have variations to the above rules for the determination of when an individual is a resident.
Most states follow the common law definition of domicile. Black’s Law Dictionary defines “domicile” as follows:
The place at which a person has been physically present and that the person regards as home; a person’s true, fixed, principal, and permanent home, to which that person intends to return and remain even though currently residing elsewhere.
In other words, “domicile” is where one lives and intends to make his or her permanent home. Because of the subjective nature of determining where one intends to make his or her permanent home, many states also provide a more objective definition for individuals who would be subject to the particular state’s income and estate taxes.
These are just some of the questions that must be asked when an individual is contemplating a change in residence.
Failure to do most of the previous items will cause the jurisdiction to question whether a taxpayer has really changed their domicile. However, the above checklist is not all in-compassing. Each individual has their own distinct facts and circumstances and therefore, every taxpayer’s situation is different.
There have been many instances where an individual could be deemed a resident of more than one state or jurisdiction if they maintain residences in both jurisdictions. The most famous case in this area was the Estate of John T. Dorrance, who was the founder of Campbell Soup. Both Pennsylvania and New Jersey Courts claimed Mr. Dorrance was a resident of their respective states at the time of his passing, subject to state estate taxes. The U.S. Supreme Court would not provide an opinion since it determined that Mr. Dorrance had not clearly established a domicile in one state or the other. The result was the estate paid state estate taxes to both states of approximately $26 million.
Taxpayers should keep contemporaneous diaries or detailed schedules. Hand written diaries or computer calendars are some of the resources that can be used. Third party documents such as credit cards, bills, passports, airline tickets, etc. should be kept in order to verify the taxpayer’s record of days. The burden of proof is on the taxpayer to prove the number of days. Remember, any part of a day (with certain exceptions) in a jurisdiction counts as a day for residency purposes.
This sounds like a lot work. However, the consequences can be very costly. Starved for revenue and hesitant to raise taxes, states are trying to get more revenue from residents through increased enforcement. Many of the estates where a change of residence has occurred will likely be reviewed and audited by the taxing authorities. This can lead the heirs to feel much frustration and anxiety. Proper planning and guidance should be done with your tax professional when residency issues arise to avoid any adverse tax consequences.
A partner based out of WS+B’s New York office, Al has over 30 years of professional accounting experience. He specializes in trusts and estates and is a certified public accountant in the state of New York. Al helps clients plan their estates to facilitate a smooth transfer of wealth through the use of creative gifting techniques. He assists clients, attorneys, executors and trustees in the accounting, taxation and administration of trusts and estates. He also focuses on estate and gift tax planning and charitable planning through the use of private foundations, split-interest trusts and public charities.
Al received his BBA degree in accounting from Pace University and earned an MS degree in taxation from Baruch College. Al is a member of the American Institute of Certified Public Accountants (AICPA) and the New York State Society of Certified Public Accountants (NYSSCPA). He serves on the Estate Planning Committee and the Trust and Estate Administration Committee for the NYSSCPA. He is also a director of the Thomas and Jeanne Elmezzi Private Foundation and serves as an executor and trustee for estates and trusts. Prior to joining WS+B, Al was a partner with EisnerLubin llp (merged with WS+B in 2011). He resides in Nassau County, NY.
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