Advanced Estate Planning - Welcome to the Oregon State … · · 2015-11-14Advanced Estate Planning. Advanced Estate Planning ii ... F Planning turned upside down—income tax basis

Cosponsored by the Estate Planning and Administration Section

Friday, June 12, 2015 8:30 a.m.–4:30 p.m.

6 General CLE credits and 1 Ethics credit

Advanced Estate Planning

Advanced Estate Planning ii

ADVANCED ESTATE PLANNING

SECTION PLANNERS

Philip Jones, Duffy Kekel LLP, PortlandJack Rounsefell, Attorney at Law, Portland

Robin Smith, Attorney at Law, PortlandKatharine West, Wyse Kadish LLP, Portland

Eric Wieland, Samuels Yoelin Kantor LLP, Portland

OREGON STATE BAR ESTATE PLANNING AND ADMINISTRATION SECTION EXECUTIVE COMMITTEE

Matthew Whitman, ChairErik S. Schimmelbusch, Chair-Elect

Jeffrey M. Cheyne, Past ChairMelanie E. Marmion, Treasurer

Ian T. Richardson, SecretaryStuart B. AllenEric R. Foster

Janice E. HattonAmelia E. HeathPhilip N. Jones

Holly N. MitchellJeffrey G. Moore

Hilary A. NewcombTimothy O’Rourke

Robin A. SmithMargaret ViningEric J. Wieland

The materials and forms in this manual are published by the Oregon State Bar exclusively for the use of attorneys. Neither the Oregon State Bar nor the contributors make either express or implied warranties in regard to the use of the materials and/or forms. Each attorney must depend on his or her own knowledge of the law and expertise in the use or modification of these materials.

Copyright © 2015

OREGON STATE BAR16037 SW Upper Boones Ferry Road

P.O. Box 231935Tigard, OR 97281-1935

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TABLE OF CONTENTS

Schedule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v

Faculty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii

1. Apportionment of Federal and Oregon Estate Taxes—Planning and Pitfalls. . . . . . . . . 1–i— Stephen Kantor, Samuels Yoelin Kantor LLP, Portland, Oregon

2. Estate Planning and Administration with S Corporations . . . . . . . . . . . . . . . . . . . 2–i— Amelia Heath, US Trust, Bank of America Private Wealth Management, Portland, Oregon— Jeff Chaidez, US Trust, Bank of America Private Wealth Management, Portland, Oregon

3. The Past, Present, and Future of the IRS Federal Estate Tax Program . . . . . . . . . . . . . 3–i— Richard Eichen, Attorney at Law, Portland, Oregon

4. Navigating the Sea Change—Planning for Married Clients . . . . . . . . . . . . . . . . . . 4–i— Patrick Green, Davis Wright Tremaine LLP, Portland, Oregon

5. From Elementary and Effective to Hot and Sophisticated: 30 Great Ideas in 60 Minutes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–i— Stephen Lane, Gleaves Swearingen LLP, Eugene, Oregon

6. Asset Protection Planning: A Few Simple Techniques and an In-Depth Look at Domestic Asset Protection Trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–i— Joshua Husbands, Holland & Knight LLP, Portland, Oregon

7. Ethical Issues for Advanced Trust and Estate Lawyers—Presentation Slides . . . . . . . . 7–i— Allison Martin Rhodes, Holland & Knight LLP, Portland, Oregon

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SCHEDULE

7:30 Registration

8:30 Apportionment of Federal and Oregon Estate Taxes—Planning and PitfallsF The rules under federal and Oregon statutory and case lawF Proactive estate tax apportionment planningF Drafting effective apportionment clausesF Common mistakes in apportionmentStephen Kantor, Samuels Yoelin Kantor LLP, Portland

9:00 Estate Planning and Administration with S CorporationsF Popular estate planning techniquesF Income tax considerationsF Permissible shareholders, including trusts and estatesF Requirements to make and keep an S electionJeff Chaidez, US Trust, Bank of America Private Wealth Management, PortlandAmelia Heath, US Trust, Bank of America Private Wealth Management, Portland

10:00 Break

10:15 The Past, Present, and Future of the IRS Federal Estate Tax ProgramF The past—the people, tax law, and processF The present—what has changed, what remains constantF The future—examination redux, technology, and electronic filingRichard Eichen, Attorney at Law, Portland

11:15 Navigating the Sea Change—Planning for Married ClientsF The complexity of advising, drafting, and administering estate plans for today’s married

couplesF Replacing conventional estate planning strategies with simpler plansF Building in flexibility when it comes to estate and income tax considerationsF Case examples and sample languagePatrick Green, Davis Wright Tremaine LLP, Portland

12:15 Lunch

1:15 Elementary and Effective: 30 Great Ideas in 60 MinutesF Tricks and traps with tax favored accountsF Planning turned upside down—income tax basis and transfer taxesF Trusts for all seasons and reasonsF Special lessons from the pastStephen Lane, Gleaves Swearingen LLP, Eugene

2:15 Asset Protection: Simple Techniques and an In-Depth Look at Domestic Asset Protection TrustsF State law asset protection optionsF The structure and requirements of domestic asset protection trustsF Gift, estate, and income tax issuesJoshua Husbands, Holland & Knight LLP, Portland

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3:15 Break

3:30 Legal Ethics for Estate Planning AttorneysAllison Martin Rhodes, Holland & Knight LLP, Portland

4:30 Adjourn

SCHEDULE (Continued)

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FACULTY

Jeff Chaidez, US Trust, Bank of America Private Wealth Management, Portland. Mr. Chaidez is a Senior Vice President and Private Client Manager in the Portland office of U.S. Trust. He works closely with high–net worth individuals and families, tailoring financial strategies and offerings to their goals and priorities. He has particular expertise in providing practical guidance during periods of personal or business transitions. Prior to joining U.S. Trust, Mr. Chaidez was the owner of Stefani Chaidez, a CPA and business advisory firm. Mr. Chaidez holds the Certified Public Account (CPA) designation.

Richard Eichen, Attorney at Law, Portland. Mr. Eichen’s areas of expertise are estate and gift tax, fiduciary income tax, and valuation. Prior to entering private practice in January 2015, Mr. Eichen spent his career as an estate tax attorney with the Internal Revenue Service in Portland. He has also served as an expert witness on the topic of federal estate and fiduciary income tax. Mr. Eichen is a regular presenter on estate, gift, and fiduciary income tax topics.

Patrick Green, Davis Wright Tremaine LLP, Portland. Mr. Green focuses his practice on wealth, business succession, and estate planning and administration for high–net worth families and business owners. He also implements complex charitable giving plans, including charitable lead and remainder trusts and donor-advised funds. Mr. Green is a Fellow of the American College of Trust and Estate Counsel (ACTEC) and a member of ACTEC’s Business Planning Committee and State Laws Committee. He is a member of the American Bar Association, Multnomah Bar Association, and Estate Planning Council of Portland. Mr. Green frequently lectures on strategic wealth transfer strategies to professionals throughout the country. He holds an LL.M. in Taxation from the University of Miami School of Law.

Amelia Heath, US Trust, Bank of America Private Wealth Management, Portland. Ms. Heath is a Senior Vice President and Senior Trust Officer with U.S. Trust, Bank of America Private Wealth Management. She works with individuals, families, and professional advisors on matters regarding estate, retirement, and financial planning and the administration of trust and investment management accounts. Prior to joining U.S. Trust, Ms. Heath’s law practice focused on wealth transfer and tax planning, business succession planning, and estate and trust administration; she does not give legal advice in her current role at U.S. Trust. She is a member of the Oregon State Bar Estate Planning and Administration Section Executive Committee and the Estate Planning Council of Portland Seminar Planning Committee.

Joshua Husbands, Holland & Knight LLP, Portland. Mr. Husbands, a member of the firm’s Private Wealth Services Section and chair of its national life insurance practice, represents clients in an array of business, tax, business succession, and estate planning matters, including business reorganizations, acquisitions, and divestitures. Mr. Husbands is a Fellow of the American College of Trust and Estate Counsel and a member of the Estate Planning Council of Portland, Inc., Board of Directors and the Portland Tax Forum Board of Directors. He often writes and speaks on a number of business, tax, life insurance, and asset protection matters concerning businesses and high–net worth individuals. Mr. Husbands is admitted to practice in Oregon and Washington.

Stephen Kantor, Samuels Yoelin Kantor LLP, Portland. Mr. Kantor’s practice areas are estate planning, trusts, taxation, charitable planning, corporations and partnerships, estate and trust administration, real estate, and general business. He is a member and past chair of the Oregon State Bar Estate Planning and Administration Section, an adjunct member of the American Bar Association Section on Real Property, Probate and Trust Law and Section of Taxation, and a member of the Oregon State Bar Real Estate & Land Use and Taxation sections, Oregon Society of Certified Public Accountants CPE Strategic Interest Team, American Society of Certified Public Accountants, Financial Planning Association, Estate Planning Council of Portland Board of Directors, American College of Trust and Estate Counsel State Law Committee, and Multnomah County Probate Advisory Committee. Mr. Kantor served as editor and coauthor of Administering Trusts in Oregon (Oregon CLE 2007). He is a regular speaker before many types of professional groups, including realtors, attorneys, and certified public accountants. Mr. Kantor is the 1994 recipient of the Oregon State Bar President’s Award for Membership Service. In addition to practicing law, Mr. Kantor is a Certified Public Accountant.

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Stephen Lane, Gleaves Swearingen LLP, Eugene. Mr. Lane’s practice includes will and trust design and operation, family and business taxes, customized IRA and 529 college saving plans, tax-sensitive wealth preservation and transmission, use of income tax grantor trusts, complex tax formula lifetime gift strategies, and qualified personal residence trusts. Mr. Lane is a Fellow of the American College of Trust and Estate Counsel.

Allison Martin Rhodes, Holland & Knight LLP, Portland, OR. Ms. Martin Rhodes is cochair of the Holland & Knight Legal Profession Team. She focuses her practice on legal ethics and risk management, law firm organization, and attorney disciplinary defense. Ms. Martin Rhodes advises both law firms and lawyers on ethical and fiduciary issues related to lateral hiring, law firm dissolution, and expulsion matters. In that context, she represents lawyers and law firms in litigation among themselves. She is a frequent author and speaker on the law of the legal profession and is the coauthor, with Ron Mallen, of the leading treatise on the topic, Legal Malpractice.

FACULTY (Continued)

Chapter 1

Apportionment of Federal and Oregon Estate Taxes—Planning and Pitfalls

Stephen Kantor1

Samuels Yoelin Kantor LLPPortland, Oregon

1 Special thanks to Justin Curtiss, Research Assistant.

Contents

I. Background. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–1A. The Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–1B. Allocation Among Estate Beneficiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–1

II. Oregon Law: The Controlling Statute . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–1A. Basic Statutes: ORS §116.303–§116.383. . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–1B. Uniform Estate Tax Apportionment Act. . . . . . . . . . . . . . . . . . . . . . . . . . . 1–1C. Definitions Under ORS §116.303 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–2D. The Basic Rule: Tax Apportionment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–2

III. The Internal Revenue Code and Rights of Recovery. . . . . . . . . . . . . . . . . . . . . . . . 1–5A. Application of the Internal Revenue Code . . . . . . . . . . . . . . . . . . . . . . . . . 1–5B. IRC Section 2205—Reimbursement out of Estate. . . . . . . . . . . . . . . . . . . . . . 1–5C. IRC Section 2206—Liability of Life Insurance Beneficiaries . . . . . . . . . . . . . . . . 1–6D. IRC Section 2207—Recipients of Property over Which Decedent Had a Power

of Appointment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–7E. IRC Section 2207A—Right of Recovery in the Case of Certain Marital Deduction

Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–8F. IRC Section 2207B—Right of Recovery Where Decedent Retained Interests . . . . . . 1–8G. Excess Accumulations Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–8H. IRC Section 2032A(c)—Additional Estate Tax on Dispositions by Qualified

Heirs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–9I. Generation Skipping Transfer Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–9J. Determinations of Tax Apportionment Under Oregon Law . . . . . . . . . . . . . . . 1–9K. Collection of Apportioned Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–10L. Obligations of the Personal Representative . . . . . . . . . . . . . . . . . . . . . . . . 1–10M. Oregon Application for Discharge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–11N. Foreign Personal Representatives (ORS 116.373) . . . . . . . . . . . . . . . . . . . . . 1–11

IV. The General Rules of Tax Apportionment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–11A. Applicability to Federal and State Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–11B. Effective Date of Apportionment Statute . . . . . . . . . . . . . . . . . . . . . . . . . 1–14C. Interest and Penalties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–14D. Exemptions, Deductions, and Credits . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–14E. Ratable Apportionment Among Beneficial Interests . . . . . . . . . . . . . . . . . . . 1–14F. Method of Securing Apportionment . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–16G. Intra-Residuary Methods of Apportionment . . . . . . . . . . . . . . . . . . . . . . . 1–16

V. Practice Tips . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–17A. Drafting of Tax Apportionment Clauses. . . . . . . . . . . . . . . . . . . . . . . . . . 1–17

Chapter 1—Apportionment of Federal and Oregon Estate Taxes—Planning and Pitfalls

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B. Specific Devises of Tangible Property and “String Transfers” . . . . . . . . . . . . . 1–19C. Charitable Bequests . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–20D. Defining Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–21E. Marital Deduction Clauses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–22F. Generation Skipping Transfer Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–26G. Revocable Living Trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–30H. Special Use Valuation Recapture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–32I. Oregon Natural Resource Credit Recapture . . . . . . . . . . . . . . . . . . . . . . . 1–33J. Problem Areas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–34K. Tax on Adjustable Taxable Gifts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–38L. Disclaimers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–39

VI. Equitable Adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–40A. The Basic Dilemma . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–40B. Basic Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–40

VII. Abatement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–41A. General Rules. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–41B. Special Situations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–42C. General Order of Abatement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–42D. Abatement Within Classes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–42E. Tangible Personal Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–42F. Sale of Specifically Devised Property . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–42G. Planning for Abatement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–43H. Determine Intent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–43

Contents (continued)


Advanced Estate Planning 1–1

I. BACKGROUND

A. The Problem

1. The issue which must be addressed in tax apportionment, stated simply, is "Whobears the burden of tax?"

2. Although the testator generally has the ability to control the allocation of tax amongbeneficiaries, too often the matter is not even discussed between the testator and theattorney. As a result, a method of apportionment contrary to the goals of the testator (andtoo often contrary to the family plan, as well) evolves.

B. Allocation Among Estate Beneficiaries.

1. Generally, the practitioner must discuss estate tax apportionment with client duringthe planning process.

2. Often, the testator wants the burden of taxes to be shared by all beneficiaries.However, the testator may indicate his or her desire to exempt certain favored gifts orfavored beneficiaries from the burden of tax. It is essential that this issue is discussed withrespect to every gift under the Will or Trust.

3. The problem manifests itself to a greater extent when the bulk of the estate passes toa spouse. In this case, absent careful planning, one of two results will arise:

a. Certain specific bequests, intended to be paid in full, could be reduced orextinguished entirely because of tax apportionment;

b. The spouse's share could be reduced by a pro rata share of taxes whichserves to limit the marital deduction and further increase taxes.

II. OREGON LAW: THE CONTROLLING STATUTE

A. Basic Statutes: ORS §116.303 - §116.383.

B. Uniform Estate Tax Apportionment Act.

1. In 1969, the Oregon Legislature adopted the Uniform Estate Tax ApportionmentAct, embodied in ORS §§116.303 -116.383 (the “State Apportionment Statute”). Thepurpose of the law was to make uniform a reasonable and understandable set of rules to befollowed when the issue of apportionment of federal estate tax and Oregon inheritance taxarises.



2. Expenses of administration, which pose a similar problem, are dealt with separatelyunder the abatement rules of ORS §116.133.

3. Oregon law directs full apportionment of taxes, sometimes referred to as "outsideapportionment". Outside apportionment, as opposed to "inside apportionment", providesthat taxes will be apportioned not only among the takers of the probate assets, but from thetakers as well of all non-probate assets of the estate which are includable for federal estatetax purposes. Inside apportionment, in the alternative, provides for full apportionment,but only within the confines of the probate estate, and does not confer authority upon thepersonal representative to apportion taxes to those who received non-probate propertyotherwise taxable in the estate.

C. Definitions Under ORS §116.303.

1. Estate - the federal gross estate or the Oregon gross taxable estate.

2. Person – any individual, partnership, association, joint stock company, corporation,government, political subdivision, governmental agency or local governmental agency.

3. Tax - federal and/or Oregon tax, but only estate tax (noticeably missing from thedefinitions is the generation skipping transfer tax and the IRC § 4974 tax on excessretirement accumulations).

D. The Basic Rule: Tax Apportionment.

1. The terms of the will control and supersede all other rules, if conflicting. ORS§116.313.

2. Apportionment in absence of provision in will:

a. It should be noted that the Statute does not define whether the term "will"includes trust or other testamentary device.

(1) Interpretation may come from other sections of the Oregon ProbateCode.

(2) Safeguard - when drafting a trust with a pourover will, includeapportionment language in the pourover will, even if the trust is thecontrolling document. At the very least, the two documents should becoordinated.

(3) Often, whether the tax clause in the decedent's will overrides a taxapportionment statute is a question of the testator's intent. In a case out ofNew York, the court determined that the decedent's will did not override theapplication of IRC §2207A, requiring a QTIP trust to pay its share of taxes



due to a partial QTIP election. Holding that the decedent intended not towipe out a residuary gift to charity through the use of a partial QTIPelection, the court required apportionment under §2207. Matter of Estate ofGordon, 510 NYS2d 815 (Sur 1986).

b. Apportionment is made "in the proportion that the value of the interest ofeach person interested in the estate bears to the total value of the interests of allpersons interested in the estate." ORS §116.313.

(1) Definition of "person interested in the estate" - generally, this isanyone receiving property as a result of the death of the testator, whether bywill, contract or operation of law. ORS §116.303(3).

(2) Apportionment is based upon values used in determining such taxes.

(a) What if value is different between federal and Oregonreturns?

(b) It appears that in this situation, each tax is apportionedaccording to the taxability of each beneficiary's bequest forpurposes of the tax being apportioned.

c. A testamentary direction to pay debts, charges, taxes and expenses ofadministration is not considered to be a direction that the estate tax rules besuperseded.

(1) If one directs by will that taxes shall not be apportioned, then thepersonal representative must determine against whom such tax shall becharged. In the absence of a contrary provision, unless the will directs thattax must be paid from the residue or some other source, apportionmentseems the only alternative. The burden for proving a basis fornonapportionment is upon the party challenging the presumption in favor ofapportionment. Matter of Bruun's Estate, 52 Or App 635 (1981) rev den,291 Or 419 (1981). See also 47C C.J.S. Internal Revenue § 742 (2015).

(2) When in doubt, direct the personal representative to apportion tax inaccordance with Oregon law. The Apportionment Statute was carefullyconsidered by the drafters of the Uniform Laws to be the most equitablemethod of allocation of taxes among beneficiaries of an estate. Thepractitioner should think long and hard about a contrary method ofapportionment in each situation, and should strongly consider relying uponthe State Apportionment Statute in the absence of compellingconsiderations to the contrary. Reliance upon the State ApportionmentStatute serves to allocate the tax ratably among all beneficiaries of thetaxable estate whose bequests serve to bear the burden of the tax. This is



sometimes referred to as "equitable apportionment". Any other method ofapportionment would provide for a disproportionate allocation of such taxburden.

(3) For an excellent discussion of this issue, see James R. Kanner, TaxApportionment Clauses That Carry Out a Client's Intent, 19 Est. Plan. 150,150 (1992).

d. Allowances for Exemptions, Deductions and Credits:

(1) Generally, allowances which reduce the effect of apportionmentupon beneficiaries will be given for:

(a) any exemptions granted;

(b) any specific classifications made of persons interested in theestate;

(c) deductions; and

(d) credits. ORS 116.343(1).

(2) Exemptions or deductions because of the relationship of a certainbeneficiary or the purpose of a gift generally inure to the beneficiary. ORS116.343(2). Examples:

(a) exemption for property held between spouses by theentireties;

(b) marital deduction;

(c) charitable deduction;

(d) Exception: when the interest is subject to a non-deductibleprior present interest, the tax on the prior present interest ischargeable to principal. ORS §116.343(2).

(3) The credit for tax on prior transfers, the credit for gift taxes paid andthe credit for foreign estate taxes are apportioned prorata amongbeneficiaries of the property subject to the credit. ORS §116.343(3).

e. The tax is not apportioned among income interests and remainder interests,between life tenants and remaindermen, and the like. Instead, the tax is charged tothe corpus of the asset subject to the interests. ORS §116.353. This could createserious problems with respect to the creation of charitable remainder trusts and



other qualifying charitable split interest gifts under IRC §2522. If tax is paidagainst the charity's share, this may upset the deductibility of the gift. Therefore, aprovision in the governing instrument directing taxes away from the charitablebequest is essential.

III. THE INTERNAL REVENUE CODE AND RIGHTS OF RECOVERY

A. Application of the Internal Revenue Code.

A number of provisions exist in the Internal Revenue Code regarding rights of recovery ofa personal representative for tax he or she has paid. This right generally is available to recoverfrom the person otherwise receiving property taxable in the estate the proportionate share of taxfrom such property. It is important to note, however, that these are not apportionment rules. Inother words, even though under state law or the governing instrument the tax may be payable fromthe probate estate or a particular fund of assets, the Internal Revenue Code provisions authorizerecovery by the personal representative from the recipient for those taxes so incurred. This is aright to seek reimbursement or collection of previously paid taxes; it is not a right to seek paymentof the applicable taxes directly to the Internal Revenue Service. Nor is this a right to seekreimbursement for state taxes paid, inasmuch as the Code only applies to the federal taxesincurred. As a result, the federal reimbursement rules should only be used as a last resort. Amuch more effective method of apportionment and provision for payment of tax is to deal in thegoverning instrument itself with the collection and payment of such tax, or to rely upon state lawfor apportionment procedures. However, in a full apportionment will, if assets outside theprobate estate or trust generate taxes, the Code gives the Personal Representative the right torecover those taxes from the recipient.

B. IRC Section 2205 - Reimbursement Out of Estate.

Under this provision, if the tax or any part thereof is paid by or collected out of the portionof the estate passing to or in the possession of any person other than the executor, the person isentitled to reimbursement from the estate for the payment of such tax. If the estate has alreadybeen distributed, then the person is entitled to a just and equitable contribution from the recipients.

1. Section 2205 establishes the fact that it is the intent of the Code to require taxes tobe paid from the estate prior to its distribution. It appears that this provision was added tothe Code because the District Director cannot be required to apportion tax among personsinterested in the estate.

2. The Section provides that the estate is primarily responsible for payment of the tax,and if assets have already been distributed and the taxes paid by someone who receivesproperty not subject to the payment of such tax, then that person has the right to seekreimbursement either from the estate or from the recipient of property who should haverightfully paid the tax in the first instance.



C. IRC Section 2206 - Liability of Life Insurance Beneficiaries.

1. With respect to life insurance, the ability of the personal representative to collecttaxes from the recipient is well defined under Section 2206 of the Internal Revenue Code.

a. In 1919, Congress provided that beneficiaries of proceeds of life insuranceincludible in the insured's gross estate must bear their share of taxes and reimbursethe personal representative, absent a contrary direction in the will.

b. Currently, IRC §2206 provides that absent a direction to the contrary in awill, if any part of a gross estate consists of life insurance proceeds includible in thegross estate and payable to a beneficiary other than the personal representative, thepersonal representative is entitled to recover from such beneficiary the taxattributable to the inclusion of such life insurance proceeds.

(1) If there is more than one beneficiary, the personal representative isentitled to recover from the beneficiaries in the same ratio.

(2) The weight of authority seems to hold that in any event there is noright to reimbursement from the insurance company itself. See, MauriceT. Brunner, Annot., Remedies and Practice Under Estate TaxApportionment Statute, 71 A.L.R. 3d 371 (1976). In other words, thePersonal Representative cannot require the insurance company to withhold.

(3) Note that the statutes specifically require apportionment in the ratiothat the share of the recipient bears to the taxable estate.

(4) Section 2206 confers upon the personal representative a right torecover tax from the beneficiary of the insurance. This is not a directapportionment rule; it is only a right of recovery.

(5) A direction in the Will to pay taxes out of the "estate" will, in alllikelihood, prevent outside apportionment. As a result, a direction to paytaxes only out of the estate will prevent proceeds of insurance in most casesfrom bearing any share of the tax burden, when the proceeds pass outside ofthe probate estate. See Old Nat. Bank of Washington v. Damon, 3 WashApp 721, 477 P2d 29 (1970); 47C C.J.S. Internal Revenue § 742 (2015).

2. The courts have interpreted §2206 very literally. For example, in a case where thedecedent's will directed that estate taxes be paid from the residuary estate, even though alife insurance policy caused the entire value of the estate to be set aside for the payment ofestate taxes, the claimants were unable to force a court to direct apportionment of tax to thelife insurance recipients under IRC §2206. The court, in Estate of Tovrea v. Nolan, Ariz845 P2d 494 (Ct App 1992), held that a direction requiring all taxes to be paid from theresiduary estate meant taxes on non-probate as well as probate property. See also



In re Estate of Agans, 196 Ariz 367, 370, 998 P2d 449, 452 (Ct App 1999); But seeIn re Estate of Fogleman, 197 Ariz 252, 263, 3 P3d 1172, 1183 (Ct App 2000).

3. IRC §2206 goes on to provide that where proceeds of life insurance are receivableby the surviving spouse and a deduction is claimed in connection with such proceeds underthe marital deduction provisions of §2056, then §2206 will not apply to such insuranceproceeds, except to the extent that such insurance proceeds are in excess of the amountclaimed as a marital deduction.

4. A major problem under §2206 deals with the method of collecting taxes when thebeneficiary chooses an optional method of settlement under the policy.

a. One approach involves collection of the proceeds directly from theinsurance company. However, the weight of authority is clearly against thisapproach. Marks v. Equitable Life Assur. Soc. of U.S., 135 NJ Eq 339 (Ch 1944).

b. It is always possible to levy upon other assets received by the beneficiaryunder the terms of the will. This creates problems, however, in the case where thebeneficiary receives only the life insurance proceeds, or in the case of unborn orcontingent beneficiaries.

c. The third, and most widely used option, permits the personal representativeto keep the estate open, and collect tax on each insurance installment as it becomesdue. Wentling, Insurance Proceeds and Estate Tax Proration, 9 U. Pitt. L. Rev.157, 169 (1948).

D. IRC Section 2207 - Recipients of Property Over Which Decedent Had a Power ofAppointment.

If any part of the estate consists of property which, under §2041, is attributable to a generalpower of appointment possessed by the decedent, then absent a contrary provision in the will, thepersonal representative has the right to recover from the recipient of such property the applicablefederal estate tax.

1. It does not matter if the recipient of the property received the same as a result of theexercise, non-exercise or release of the power of appointment. What matters is that thedecedent had a general power of appointment, and that some person received property as aresult of the death of the decedent.

2. Once again, the amount of tax attributable to inclusion of the property subject to thepower is the ratio that the value of the property bears to the total taxable estate of thedecedent.



3. To the extent that such property qualifies for the marital deduction, the CodeSection specifically relieves the recipient from the obligation to pay any such tax.

E. IRC Section 2207A - Right of Recovery in the Case of Certain Marital DeductionProperty

Under this provision, property, which is required to be taxed in a surviving spouse's estateunder §2044 because of an earlier QTIP election attributable to that property, must be paid fromthe property itself. This is true unless the governing instrument of the surviving decedent requiresthat the tax be paid from a different source. For a further discussion of these issues, see theprovisions regarding marital deduction clauses at §V E. of this outline.

F. IRC Section 2207B - Right of Recovery Where Decedent Retained Interests.

Under this Section, if part of the gross estate includes property against which taxes areassessed because the value of the property is includable in the estate under §2036, then the estate isentitled to recover from the recipient of such property the amount that the value of the propertytaxable in the estate bears to the total taxable estate.

1. Section 2207B contains two important exceptions.

a. First, the decedent may direct by Will that the recipient of such propertyshall not bear his or her share of taxes.

b. Second, and of equal importance, is the fact that this provision does notapply to enable the executor to seek recovery against a trust to which Section 664applies (a charitable remainder trust).

2. IRC §2207B provides for the right to seek reimbursement for penalties and interestattributable to the tax, just as the right exists under §2207A. Any gift taxes incurred as aresult of §2036 would also be reimbursable under the provisions of §2207B. In order towaive the right to reimbursement under §2207B, the will must contain specific reference tothe provision. A general direction against apportionment may not work to obviate theprovisions of §2207B.

G. Excess Accumulations Tax.

Under IRC Section 4974, there is a special excise tax equal to fifty percent of the amount ofthe decedent's excess accumulation in a retirement plan as of the date of death. This fifty percentexcise tax, although not an estate tax, must still be considered by the practitioner in planning for anestate with large accumulations inside retirement accounts.

1. Since there are no credits, deductions or exclusions which apply against the specialfifty percent excise tax, the issues regarding allocation of expenses and deductions to



apportioned shares do not appear with respect to this tax. Under Section 4974, the payeeof the retirement plan is liable for the fifty percent excise tax.

2. A provision in the governing instrument requiring distribution of all requiredminimum distributions should be sufficient. If the excess accumulations tax applies thenthe payee will be liable for the tax. Because the payee is receiving a distribution, they willusually pay the fifty percent tax out of the account.

4. It is essential that the practitioner carefully evaluate any potential tax on excessretirement accumulations and address the issue by requiring the estate to take the requiredminimum distributions out of the retirement accounts.

H. IRC Section 2032A(c). Additional Estate Tax on Dispositions by Qualified Heirs.

Under this provision an additional estate tax will be assessed against a "qualified heir"when he or she ceases to use or sells certain qualified use property within ten years after the deathof the decedent in whose estate a §2032A election was made. For further analysis, see paragraphV.H. of this chapter.

I. Generation Skipping Transfer Taxes.

Under the provisions of IRC §§2601 et seq., certain rules regarding the payment ofgeneration skipping transfer taxes by transferors, recipients and trusts are included. For a furtherdiscussion, see paragraph V.F. of this outline.

J. Determinations of Tax Apportionment Under Oregon Law.

1. Under ORS 116.323(1), the court in which the probate administration is proceedingmay, upon petition, determine apportionment of the tax.

2. Penalties and interest are normally apportioned in the same proportion as the actualtax.

a. However, if the court finds that the incidence of penalties and interest resultfrom delay or negligence of the personal representative, the court may apportionthe penalties and interest directly to the personal representative. See ORS116.323(3).

b. If the court finds inequity in the normal method of apportioning interest andpenalties because of special circumstances, it may direct apportionment in anymanner the court deems equitable. ORS 116.323(2).

3. In the event the court determines apportionment, such determination is prima faciecorrect in a later suit to recover from any interested person his or her share of the tax.



K. Collection of Apportioned Taxes.

1. Generally, the personal representative is charged with the duty of paying estate andinheritance taxes.

2. ORS 116.333(1) gives the personal representative, or other person in possession ofthe property, the right to withhold from property otherwise distributable to a person, his orher share of the tax.

a. It appears the personal representative can encumber or sell all or a portionof such property to pay the tax.

b. If the value of the property is insufficient to pay the tax due from thedistributee of such property, the personal representative may recover the deficiencyfrom the distributee.

c. If the property passes outside probate, ORS 116.333(1) provides thepersonal representative with a legal right to collect the tax from the recipient of theproperty.

d. The personal representative may secure a bond in the amount of theapportioned tax from the distributee if the personal representative distributes theproperty prior to final apportionment. ORS 116.333(2).

(1) Query: Is the personal representative liable for breach of fiduciaryduty if he or she does not take a bond? Could this be asserted as anaffirmative defense by the distributee?

(2) Rule of thumb: Never distribute before full apportionment oftaxes. In touchy situations, it is best not to distribute until the Estate TaxClosing Letter and the Oregon Estate Tax Closing Letter are received.

L. Obligations of the Personal Representative.

1. The personal representative is liable to pay the tax, unless he or she has beendischarged of further obligation by the court or relieved of liability pursuant to statute.

2. Under ORS 116.363, the personal representative (or other person required to paythe tax) is under no duty to bring any action against a distributee to recover his or her shareof unpaid tax until three months following final determination of the tax.

3. If, within a reasonable time following the three-month period, the personalrepresentative files suit to recover tax, the personal representative will not be liable to paythe tax, even if the tax later becomes uncollectible from the distributee.



a. The fact that the personal representative could have recovered the tax fromthe distributee at an earlier time does not alter this result.

b. The amount not recoverable will be equitably apportioned among the otherpersons interested in the estate who are subject to apportionment. ORS 116.363.Note: the statutes refer to "equitable apportionment" in this case, and notnecessarily "pro rata" apportionment.

M. Oregon Application for Discharge.

1. Commencing January 1, 2010, an executor, personal representative or trustee of anestate has a right to file a request with the ODR for a determination of tax due under Chapter 118and request a discharge for personal liability.

a. If the tax return has been filed prior to or concurrent with the dischargerequest, then the ODR has 18 months to notify the fiduciary of the amount of tax due.

2. Although the fiduciary has been discharged from personal liability, the regularestate tax statute limitations are not terminated. Thus, if a subsequent audit occurs and there is acommensurate increase in Oregon Estate Tax, then the assets of the estate, even though distributedand even though the personal representative can still be subject to levy.

3. The discharge form can be found online athttp://www.oregon.gov/DOR/BUS/docs/103-1005.pdf.

N. Foreign Personal Representatives (ORS 116.373).

1. If a distributee is domiciled or owns property in Oregon, the statutes give a foreignpersonal representative jurisdiction in Oregon to institute an action for collection of thedistributee's share of federal estate tax or state inheritance tax payable from the foreignestate.

2. In this case, the determination of the court in the foreign state having jurisdiction ofthe estate administration regarding apportionment shall be deemed prima facie correct inOregon.

IV. THE GENERAL RULES OF TAX APPORTIONMENT

A. Applicability to Federal and State Tax.

It is important to note that most state statutes, including the Oregon statute, apply to bothfederal and state taxes. The statutes assume that a tax has been or will be paid, and thendetermines upon whom the ultimate burden lies. In re Estate of McMahon, 2014AP2037, 2015 WL1824109 (Wis Ct App Apr. 23, 2015); New York Trust Co. v. Doubleday, 144 Conn 134, 128 A2d



192 (1956). While most questions of tax apportionment deal with federal tax, there is no specificprovision of the Internal Revenue Code dealing with apportionment of federal tax. Instead, thequestion has been left to each state to determine. Riggs v. Del Drago, 317 US 95, 63 S Ct 109, 87L Ed 106 (1942); Estate of Ginn v. Almond, 427 SW3d 291, 294 (Mo Ct App 2014).

1. Most states apportion tax among the beneficiaries receiving taxable property in theproportion such beneficiaries take the property.

2. However, some states, such as Florida, require that all taxes be charged to theresidue, absent an overriding provision in the will. Prior to the 1930's, the Florida rulewas the rule of the land. At that time, most cases passing upon the question as to theburden of estate taxes held that estate taxes were not unlike any other debts ofadministration, and should be paid from the residue. The landmark change in thisprecedent was provided by the New York statute in 1930. At that time, the New Yorklegislature determined that taxes should be divided prorata, i.e., apportioned between thevarious persons receiving benefits from the estate, in whatever form. "The principalobjection to an estate tax has been that where the decedent dies leaving a will, and makesno provision therein to the contrary, the entire burden of the tax must be borne by theresiduary legatee or legatees. Experience has demonstrated that in most estates theresiduary legatees are the widow, children, or nearer or more dependent relatives. Thishas been one of the objections to the Federal Estate Tax Law in New York. The burden ofthe tax has been imposed upon the residuary legatees not only as to property passing underthe will, but also upon transfers whether by gift or by inter vivos trust." Reprinted fromthe 4th Report of the Temporary State Commission on the ... Simplification of the Law ofEstates (of New York), Legislative Document (1965) No. 19, p. 337 (1645), BNA TaxManagement Portfolios, No. 219-3d, A-24. The New York statute was questionedconstitutionally in the Riggs v. Del Drago case, supra, and was upheld. In the Riggs case,the Supreme Court emphasized that a method of providing for federal estate tax paymentand apportionment was a determination to be made by each state. The court did notdisagree with the analysis undertaken by the New York State Commission to InvestigateDefects in the Law of Estates, which was the body passing the New York statute. See alsoEstate of Ginn v. Almond, 427 SW3d 291, 294 (Mo Ct App 2014).

3. There is strong public policy in favor of statutory apportionment of estate taxes.In re Constr. of Last Will & Testament of Sued, 33 Misc 3d 1206(A), 941 NYS2d 537 (Sur2011); In re Shubert's Will (State Report Title: Matter of Shubert), 10 NY2d 461, 180NE2d 410 (1962).

a. As a result, courts generally have no equitable power to amend theapportionment formula provided by statute.

b. The only exception is a clear mandate to the contrary by the testator.McCoy v. C.I.R., 97 TCM (CCH) 1312 (TC 2009); New York Trust Co. v.Doubleday, 144 Conn 134, 128 A2d 192 (1956).



c. Any testamentary direction to the contrary must be clear and unambiguous.In re Estate of McMahon, 2014AP2037, 2015 WL 1824109 (Wis Ct App Apr. 23,2015).

d. The effect of whether taxes are charged to the residue or are apportionedamong beneficiaries can be dramatic. Take the following example: at A's death,he left five beneficiaries. Presume an unused exemption of $5 million. B and Ceach receive a $1.5 million specific bequest. D receives a $3 million bequest. Eand F share the residue equally. A's net taxable estate is $7,550,000, less expensesof administration of $50,000. Federal estate taxes are $800,000. Thebeneficiaries are all individuals.

Effect of Prorata Sharing of Tax

Gross Net NetAmount % of Share of % ofReceivable Whole Taxes Estate Estate

B: $1,500,000 21.4% $171,200 $1,328,800 21.4%

C: 1,500,000 21.4% 171,200 1,328,800 21.4%

D: 3,000,000 42.9% 343,200 2,656,800 42.9%

E: 500,000 7.15% 57,200 442,800 7.15%

F: 500,000 7.15% 57,200 442,800 7.15%

$7,000,000 100% $800,000 $6,200,000 100%

Effect of Paying Tax from Residue

Gross Net NetAmount % of Share of % of AfterReceivable Whole Taxes Estate Tax Estate

B: $1,500,000 21.45% -0- $1,500,000 24.2%

C: 1,500,000 21.4% -0- 1,500,000 24.23%

D: 3,000,000 42.9% -0- 3,000,000 48.4%

E: 500,000 7.15% 400,000 100,000 1.6%

F: 500,000 7.15% 400,000 100,000 1.6%

$7,000,000 100% $800,000 $6,200,000 100%



As the above example shows, the decision as to whether or not to apportion tax canhave a significant impact upon all beneficiaries. This is especially true withrespect to residuary beneficiaries. This effect must be even more pronouncedwhen one beneficiary is a charity to which no apportionment is attributable.

B. Effective Date of Apportionment Statute.

Generally, an apportionment statute will prevail in the case of all persons dying after itsenactment, even if the will or governing instrument was executed prior to the date of enactment ofthe statute. 42 Am. Jur. 2d Inheritance, Estate, and Gift Taxes § 284. This rule has been upheld inthe face of due process arguments to the contrary.

C. Interest and Penalties.

Some apportionment statutes require that interest and penalties on unpaid tax should alsobe apportioned. This is clearly the case in Oregon. ORS §116.303(5) defines "tax" to includeinterest and penalties.

D. Exemptions, Deductions, and Credits.

Most states' statutes provide that allowances for exemptions, deductions and credits shallinure to the benefit of the beneficiary who received the gifts upon which such exemptions orcredits are subject.

1. This is the case in Oregon. See §II D.2.d., infra. For three non-Oregon cases inwhich charities were forced to bear their proportionate share of tax, see Shriners Hosp. forChildren v. Schaper, 215 SW3d 185, 193 (Mo Ct App 2006); Estate of Boder, 850 SW2d76 (Mo 1993); and Matter of Estate of DeVoss, 474 NW2d 542, (Iowa 1991).

2. Oregon law goes further to provide that when the decedent's will or trust providesthat taxes shall be paid from the residue, such benefit is not deemed to be an added taxablebenefit to a specific devisee or legatee. Nor is this deemed to be considered a reduction ofthe value of the residuary devise. OAR §150-118.010(6). Rather than treating this as abenefit or detriment to any particular beneficiary, it is merely deemed to be an appropriatemethod of dealing with the tax burden.

E. Ratable Apportionment Among Beneficial Interests.

Under Oregon law, taxes are to be apportioned among the persons interested in the estate inaccordance with the ratio which the property each interested person receives bears to the totaltaxable amount of property.

1. Generally, these terms apply to beneficiaries only, and not to creditors of the estate.Accounting of Vernon, 107 Misc 2d 1021, 1022, 437 NYS2d 562, 563 (Sur 1981); In reOppenheimer's Estate, 166 Misc 522, 2 NYS2d 786 (Sur 1938).



2. Nor is apportionment charged to a person who receives an amount in compromiseof a will contest. See In re Richheimer's Estate, 200 Misc 345, 102 NYS2d 750 (Sur 1951);But see Matter of Estate of Barnard, 867 P2d 47, 49 (Colo App 1993).

3. Taxes may also be apportioned against the donee of a gift later includible in thedonor's estate, even if the donee has since died. See 42 Am. Jur. 2d Inheritance, Estate,and Gift Taxes § 288.

4. When a surviving spouse elects to take against the will, the share subject to theelection will generally be computed as against the "net estate", after reduction for expensesof administration, but not taxes. In other words, taxes should still be apportioned againstthe spouse's elective share, if and to the extent any taxes are chargeable to such share. 42Am. Jur. 2d Inheritance, Estate, and Gift Taxes § 290.

5. When the decedent creates an inter vivos trust which is includible in the gross estateunder §§2036, 2037 or 2038, the trust must bear its share of the tax, absent a contraryprovision in the will. 42 Am. Jur. 2d Inheritance, Estate, and Gift Taxes § 284; In re Abry'sTrust, 30 Misc 2d 265, 214 NYS2d 555 (Sup Ct 1961). This is strong incentive for amethod of coordinating taxes between the will and an inter vivos trust. See V., infra.

6. It is clear that in the absence of a contrary direction in a will, a life insurancebeneficiary must pay his or her share of tax. In one case, it was held that the insurancecompany, when holding proceeds on deposit as an escrow agent or pursuant to aninterpleader, may be charged with a proportionate share of the tax.

a. However, the rules do not go so far as to make an insurance company a"withholding agent" in cases where proceeds are payable in the form of an annuity.In re Zahn's Estate, 300 NY 1, 87 NE2d 558 (1949); In re Moreland's Estate, 351 Pa623, 42 A2d 63 (1945).

b. If the decedent's will specifically provides that all taxes should be paid fromthe residue, then the beneficiary of a life insurance policy on the decedent's life willlikely be exonerated from tax. See S. Alan Medlin, Howard M. Zaritsky, F.Ladson Boyle, Construing Wills and Trusts During the Estate Tax Hiatus in 2010,36 ACTEC L.J. 273, 297 (2010); Estate of Tovrea v. Nolan, 173 Ariz 568, 845 P2d494 (Ct App 1992).

7. Generally, as between a life estate and remainder interest, estate taxes areapportioned to corpus. The rationale behind this rule rests upon the fact that to the extentcorpus is reduced, there is a corresponding reduction of the interest of the life tenant. Thesame holds true with respect to apportionment against a trust created by the decedent. 71A.L.R.3d 247. Under the general rule, this holds true even when a charity is the remainderbeneficiary and the life tenant's share is taxable.



a. In Estate of Malpas, 7 Cal App 4th 1901, 9 Cal Rptr 2d 806 (1992), theCourt held that even though there was no bequest of liquid assets to assist a lifetenant in the decedent's residence in paying the tax, the California FullApportionment Statute should still prevail. See also Simpson v. White, 57 Cal App4th 814, 820, 67 Cal Rptr 2d 361, 365 (1997).

b. What is even more important is the Court's statement that the will wasprepared by an attorney who presumably knew the California apportionment rulesand therefore intended this result. Query, whether this dicta establishes potentialattorney malpractice liability?

F. Method of Securing Apportionment.

1. When apportionment is necessary, the best practice is to secure an order of theprobate court directing apportionment. This is normally done in connection with filing ofthe Final Account. However, an Order for Apportionment may be taken in connectionwith a Petition for Construction of the Will. The executor's computations should besubmitted to the court and served upon all interested persons.

a. It is best to withhold from each bequest an amount sufficient to pay its shareof the apportioned tax, subject to court order.

b. This is especially true since the ruling of the Probate Court has the force andeffect of a final judgment.

2. The Court, in making a determination, must rely on the actual findings of the taxingauthorities as to the amount of tax being apportioned. The court cannot rule that thetaxing authorities should have come to a different tax result.

G. Intra-residuary Methods of Apportionment.

1. If the Will does not evidence a contrary intent, a direction to pay taxes from theresidue means the residue of the probate estate, and not the remainder of the federal taxableestate. Grimes v. Grimes, 242 Or 158, 408 P2d 731 (1965).

2. Even though a will may direct that taxes shall be paid out of the residue, thequestion of apportionment still arises when there is more than one residuary beneficiary.While such a direction exempts pre-residuary gifts, the burden of taxes must still beapportioned among residuary beneficiaries.

a. Ordinarily, this creates little problem, because taxes are first paid, and theresidue after taxes is then apportioned among residuary legatees in the proportionsstated in the governing instrument.



b. However, in some cases, this can create significant problems, such as whena partial distribution has previously been paid, and the remainder is insufficient todischarge the remaining tax liability.

3. In most cases, taxes will be apportioned among residuary legatees under the samerules governing apportionment of non-residuary devises. In other words, charities, etc.should still inure to the benefit of their particular exemptions, deductions or credits. 42 Am.Jur. 2d Inheritance, Estate, and Gift Taxes § 273 (2015); In re Smithers' Estate, 15 Misc 2d701, 702, 181 NYS2d 702 (Sur 1959).

V. PRACTICE TIPS

A. Drafting of Tax Apportionment Clauses.

1. Clearly, it is dangerous, at best, to draft a particular apportionment scheme into awill without full knowledge of all the facts which will be present at the testator's death.

a. What if assets change?

b. What if a beneficiary dies and his or her bequest lapses?

c. What happens in the event of a will contest?

d. What if the system of taxation changes?

2. A properly drafted tax clause in a will should address, among other things, thefollowing topics:

a. Which taxes are being apportioned, i.e., the estate tax, the generationskipping transfer tax, state estate tax, and the Section 4974 additional tax.

b. The clause, if not referring to Oregon statute, should also address whethernon-probate property will bear its burden of tax, i.e., whether the apportionmentscheme is an inside apportionment or outside apportionment scheme.

c. The clause should address whether equitable apportionment will beconsidered. In other words, will those bequests, such as marital bequests, whichdo not incur any tax, still bear a share of the tax? Under equitable apportionment,these bequests are relieved from an aliquot share of the tax.

d. If there is a desire to allocate certain credits or other tax benefits torecipients of assets subject to those credits, this desire should be expressed in theinstrument.



e. To the extent that any installment or annuity payouts exist, which generallyrequire charging of the tax to principal, any different apportionment scheme shouldbe specifically identified.

f. The apportionment scheme should indicate whether or not apportionmentshould also apply to the payment of any interest and penalties on taxes to whichthey relate.

g. If any deductible claims which are similar to or in lieu of bequests areincluded, such as payments to a spouse under a Prenuptial Agreement, then thedrafter should determine whether or not to apportion taxes to those bequests.

h. If it is appropriate in certain cases to identify certain assets for tax payment,this should be specified in the instrument.

3. The safest alternative is to take one of three alternative approaches:

a. Require all taxes to be paid from the residue;

b. Require all taxes on probate assets to be paid from the probate residue andall taxes on non-probate assets to be apportioned directly to those assets; or

c. Require that taxes be apportioned in accordance with Oregon law.

4. The drafter must seriously consider the results of each decision at the time thedocument is drafted.

a. The will should contain a provision to the effect that if the residue isinsufficient to pay taxes, then the apportionment statute shall apply to the excess.

b. In some cases, a particular testator may want a specific devisee to pay his orher share of the tax. This may be true when one child receives a gift of cash andthe other child receives illiquid assets, such as an interest in a closely held business.In this case, a specific direction that a gift shall be charged with its share of taxwould be appropriate. Caveat: Make sure an analysis of the potential tax isproperly undertaken, so the gift of non-liquid assets might be supplemented with anextra amount to pay the tax.

(1) The opposite may be true where the decedent leaves two children,one interested in the family business and one who is not. In this case, adirection to pay taxes from the residue, coupled with a specific devise of thefamily business to child A and a residuary devise to child B, could wipe outchild B's interest in the estate.



(2) The adverse effect of the above fact situation could be amelioratedwith proper life insurance and liquidity planning.

5. In order to be effective, a testamentary direction against apportionmentmust be clear and unambiguous. This is so because of the strong public policyfavoring statutory apportionment. In the event the testator wants taxes to be paidfrom the residue, the will should say so in clear and unambiguous language. Thisdirection should also deal with taxes on non-probate assets.

a. A direction merely to pay taxes from the estate has been deemed tobe a direction in favor of apportionment. Skaggs v. Yunck, 10 Or App536, 500 P2d 1230 (1972); Matter of Estate of Shoemaker, 22 Kan App 2d444, 449, 917 P2d 897, 900 (1996); See also Matter of Bruun's Estate,supra. It might also be appropriate to add the words "withoutapportionment."

b. In Barlow v. Brubaker, 465 NW2d 276 (Iowa 1991), the decedent'swill provided that all taxes relating to property passing under his will bepaid from the residue of the probate estate. The Court ruled that this meantall taxes attributable to non-probate property should be fully apportioned.The Law Of Trusts And Trustees § 286.5; but see Matter of Estate ofDeVoss, 474 NW2d 542, 546 (Iowa 1991).

6. Just as important is a definition of which taxes will be subject to thetestamentary direction. The words "estate, inheritance, succession and estatetaxes, including penalties and interest" should suffice, but the instrument shouldalso deal with generation skipping taxes and the IRC § 4974 tax on excessretirement accumulations.

B. Specific Devises of Tangible Property and "String Transfers".

1. Often, a problem will manifest itself when a testator devises illiquid assets to abeneficiary under a "full apportionment" will. Suppose a beneficiary receives onlytangible property, such as non-income producing real property or a valuable article ofjewelry, without receiving any cash to pay the tax attributable to the bequest. The resultcan often create a hardship upon the beneficiary, who must either disclaim the gift or findthe funds necessary to pay the tax. There are a number of solutions to this problem:

a. Provide that taxes shall be paid from the residue;

b. Provide that the specific bequest shall not share in tax apportionment, i.e.,make the gift "free of tax" under the terms of the will;

c. Ensure that the testator includes sufficient cash together with the specificbequest, so that the tax attributable to the total gift can be paid with the cash; or



d. Advise the beneficiary in advance that the gift may be made, and cautionthe beneficiary that he or she should set aside sufficient cash to accommodatepayment of the tax upon the testator's death.

2. A similar problem results in the case where assets not transferred at death areincludible in the gross estate and are subject to tax apportionment.

a. Under federal law, proceeds of a life insurance policy transferred withinthree years of death are includible in the gross estate under §2035. Also includedare certain "string transfers", under circumstances in which the decedent made atransfer and retained certain tainted powers over the property under IRC §§2036,2037 and 2038.

b. In these cases, tax will be apportioned to the donee, transferee orbeneficiary, as the case may be.

(1) A provision in the original instrument of transfer, which exoneratesthe party succeeding to the interest from the payment of tax, should suffice,if not inconsistent with the will.

(2) However, ORS §116.303 does not include previous transfers underthe definition of "will". As a result, a determination as to whether the priorgift escapes tax apportionment by its terms may be left to the probate court.And remember, there is a strong public policy in favor of apportionment.

(3) It is safest to specifically exonerate any such gifts by including aseparate clause to that effect in the will.

C. Charitable Bequests.

1. As stated above, a bequest to a charity generally will not be charged with a proratashare of federal or Oregon tax, since the bequest usually bears no tax.

2. What about a residuary bequest to charity?

a. If the will directs that taxes shall be apportioned, this bequest shall bear notax.

b. However, if the will directs that taxes shall be paid from the residue, thenthe charity, as a residuary beneficiary, ends up bearing the tax burden. This iscompounded by the fact that since the taxes are a charge upon the residue, theamount remaining for payment to the charity suffers a corresponding reduction.As a result, the deduction for charitable bequests is reduced. The estate tax is, byvirtue of the reduced charitable deduction, correspondingly increased. This



increase reduces further the amount of residue payable to the charity, whichreduces the charitable deduction, which increases the tax, and so on. Thiscompound effect results in a complicated simultaneous equation computation.When a charity is a residuary beneficiary, the practitioner should seriously considerthe alternative of tax apportionment.

D. Defining Terms.

Once the decision is made as to how taxes shall be apportioned, it is essential that thedrafter take the steps necessary to clearly and unambiguously set forth the apportionment languagein the will, so that there is no question as to the intention of the testator.

1. The bulk of the litigation involving tax apportionment deals not with interpretationsof the statutes, but with interpretations of decedents' wills. In these cases, courts look notonly to the language of the will, but the court will consider the apparent intention of thetestator. In some cases, courts go so far as to presume that the testator's intent was tobenefit the natural objects of his bounty. See 68 A.L.R.3d 714; 71 A.L.R.3d 247.

2. In states where there is a statute providing for apportionment, there is a furtherproblem regarding whether the testator intended the statute to apply, or whether the willshould apply.

3. Take, for instance, the clause "I direct that all taxes on my estate shall be paid fromthe residue." Although this clause appears, at first glance, to be straight forward, thefollowing problems arise:

a. The sentence does not specifically define the words "taxes", "estate", and"residue". A myriad of courts have attempted to construe these words, and there islittle consistency between the decisions.

b. In In re Hoffmann's Estate, 399 Pa 96, 160 A2d 237 (1960), the court held adirection that "any and all inheritance taxes" be paid from the decedent's estate didnot apply to federal estate taxes, even though the words "and all" were included.The court relied upon the meaning of the word "inheritance", and emphasized thefact that the federal estate tax is not "an inheritance tax." An inheritance tax, it wasreasoned, is a tax on the right of succession to property, whereas an estate tax is atax on the transmission of property. But see Spaeder v. United States, 478 F Supp73, 83 (WD Pa 1978).

c. Does the word "estate" mean gross estate for federal estate tax purposes(which includes "string transfers", joint property, some life insurance proceeds andsome gifts), or does the word apply only to the "probate estate"? A simpledefinition in the will would remove any doubt.



E. Marital Deduction Clauses.

1. Under the Tax Reform Act of 1976, the federal estate tax marital deduction waslimited to the greater of $250,000 or 50% of the decedent's adjusted gross estate.Following enactment of the 1976 Act, practitioners were careful to provide that taxeswould be paid out of the non-marital share of the estate. Otherwise, the amounttransferred to the marital share would have been reduced by the amount of tax chargeablethereto, which had the effect of triggering more tax, and so on. This created a situationsimilar to that discussed in paragraph C above, regarding charitable bequests.

2. Then came the Economic Recovery Tax Act of 1981, which provided for anunlimited marital deduction. Since enactment of the 1981 Act, in most estates, there willbe no federal tax payable at the death of the first spouse. Often, though, wills are draftedto provide for a marital share (outright or in trust) and bypass trust, so that the bypass trusttakes advantage of the then-existing exemption equivalent of the federal estate tax unifiedcredit. Most of these wills contain "reduce-to-zero" marital deduction bequests, whichprovide that the marital deduction will equal that amount which, when taking into effect allother deductions and credits available to the estate, reduces the federal estate tax to zero.

a. In these cases, it is essential that the taxes attributable to the decedent'sgross estate, and all expenses of administration (not deducted on the estate taxreturn) should be charged to the non-marital share of the estate.

b. The primary focus of the tax payment clause following the 1981 Act shouldbe to place the burden of the federal estate tax and state estate taxes on the share ofthe estate not passing to the surviving spouse, so that the spouse's share continues toqualify for the federal estate tax marital deduction. In other words, such taxesshould normally be paid from the bypass trust.

3. In the event that the will establishes no bypass trust, or if the property qualifying forthe bypass trust is insufficient to pay the entire estate tax burden, the practitioner mayconsider carefully drafting the will so that taxes may be charged against any otherproperties which contribute to the tax burden.

4. What happens if the surviving spouse disclaims an interest in the estate? In manycases, practitioners now draft disclaimer wills which contemplate the fact that a spousemay disclaim a share of the estate, which later falls into either the hands of alternativebeneficiaries or into a trust similar in form to a bypass trust. Whenever the possibility fordisclaimer is contemplated (which includes almost every estate), the practitioner shouldensure that the tax allocation clause directs that any taxes which may be generated as aresult of a disclaimer should be charged against the disclaimed property, and not againstother property of the estate.

a. For instance, suppose a testator establishes a will providing a QTIP trust(income to his wife and remainder to his son), a specific bequest to his son, and the



balance, if any, to a bypass trust which provides the spouse with a limited power ofappointment. Suppose further that the will directs that taxes are to be charged tothe share passing to the son.

(1) In this situation, if the wife wants to limit the share of the son, shecould disclaim from the QTIP trust into the bypass trust, giving her moreflexibility to determine the ultimate beneficiary of the disclaimed property.Even though this may create additional tax, the terms of the instrumentwould require the tax to be paid by the son.

(2) A provision in the instrument directing all taxes attributable todisclaimed property to be paid from the disclaimed property itself wouldalleviate this unfair result.

5. The Economic Recovery Tax Act of 1981 also established a new type of maritaldeduction trust under the tax law, that being the Qualified Terminable Interest Property(QTIP) Trust. Under these provisions, found at IRC §2056(b)(7), if a personalrepresentative so elects, he or she can treat all or a portion of the property passing to a trustfor the benefit of the decedent's surviving spouse to qualify for the marital deduction, eventhough the trust is of such a variety that it would otherwise not qualify for the maritaldeduction because of the terminable interest rule. Generally, in order to qualify as a QTIPTrust, all of the income of the trust must be payable to the surviving spouse for theremainder of his or her lifetime, and no other person or entity has the right to invadeprincipal or income for the benefit of anyone other than the surviving spouse.

a. In drafting wills with QTIP provisions, remember that any taxes must becharged against the share of the trust not subject to an effective QTIP election. Inother words, taxes should be apportioned only from the share of the QTIP trustwhich does not qualify for the federal estate tax marital deduction. Thisconclusion is based upon the same reasoning applicable to apportioning taxes to thebypass trust as opposed to the marital deduction share, discussed above. It wouldbe best to provide in the governing instrument for an actual split of the QTIP intoexempt and non-exempt shares, making it easier to identify each and to justifyapportionment. Jeffrey N. Pennell, Apportionment Can Make Tax Payment MoreEquitable, 22 Est. Plan. 3 (1995).

b. Under IRC §2044, the value of the gross estate includes the value of anyproperty over which a QTIP election was made at an earlier time. Under IRC§2207A, if any part of the gross estate consists of property taxable under §2044, thedecedent's estate is entitled to recover the amount of tax attributable to inclusion ofthe QTIP property in the estate directly from the person receiving the property. Inthis case, the amount of tax attributable to the QTIP property is computed at thehighest bracket taxable in the estate of the second spouse; i.e., the tax is computedas though the QTIP property were the last item added to the taxable estate.



c. The right of the estate of the surviving spouse to collect the federal estatetax attributable to the QTIP property from the recipient of such property may besuperseded by a contrary direction in the will of the decedent in whose estate theQTIP property is taxable.

(1) These rules require meticulous planning by the practitioner.

(2) In the absence of family considerations, it is best to provide in thewill establishing the QTIP trust that unless otherwise directed, the QTIPtrust shall bear its share of taxes in the spouse's estate prior to distribution tobeneficiaries of the QTIP trust. Although this is in accordance with§2207A, that section specifically provides that taxes are chargeable fromthe "recipient" of the QTIP property, and not from the trust.

(3) With respect to a QTIP transfer which is not in trust, it may beappropriate to provide in the will of the decedent which establishes theQTIP bequest that the taxes be paid directly from the recipient, inaccordance with §2207A.

(4) On the contrary, it may happen that for some reason, payment oftaxes attributable to inclusion of the QTIP property in the surviving spouse'sestate directly from the QTIP property is not the desired result. This mayoccur when the QTIP property consists of illiquid assets, and thebeneficiaries of the QTIP trust are the same as the beneficiaries of thespouse's residuary estate. In that case, it would be appropriate, in thespouse's will, to include a provision under §2207A(a)(2) to the effect thatthe QTIP property should not be charged with any taxes attributable toinclusion of the QTIP property in the spouse's estate under §2044.

6. Be careful, however, when any planning involves the failure to seek reimbursementof taxes under §2207A from the appropriate payor. At death, failure to seek thereimbursement of taxes incurred under §2207A caused by §2044 from the beneficiaries ofthe §2044 property, and collection instead from other beneficiaries, will result in a giftfrom the beneficiaries paying the tax to the beneficiaries who should have paid the taxunder §2207A. This is true even if collection would have proved impossible. 26 C.F.R.§ 20.2207A-1(a). Therefore, if the right of reimbursement is to be waived, it must be doneby the surviving spouse in his or her testamentary instrument, by way of a specificprovision allocating the §2207A tax to a specific individual or individuals.

a. In these cases, the gift will often occur as a result of a failure by the personalrepresentative to either waive or assert the right of reimbursement under §2207A.

b. This provides another reason for exercising great caution in this area, so thatthe personal representative is not deemed to suffer liability for breach of fiduciaryduty in generating the "phantom gift tax".



7. In drafting a will clause intended to relieve marital deduction property from estatetax liability, the practitioner should consider the entire estate plan of the testator, anddesign the clause to fit the testator's needs. Normally, the goal is to optimize the maritaldeduction. In this case, a clause directing that the estate residue should bear estate taxesassessed against property passing both under and outside of the will, may serve to reducethe marital deduction, if the marital bequest consists of part of the residuary estate, asdiscussed above. This type of clause, however, would be appropriate if the maritaldeduction is provided pursuant to a pre-residuary bequest.

a. An initial analysis should be made to determine whether or not any taxeswill be payable. If taxes will not be payable because of the size of the estate, thereshould be little problem. In that case, a clause directing payment of the taxes outof the residue, even though the marital bequest is a residuary bequest, should notcause hardship. Extra care should be exercised in these cases to ensure the estatewill not grow to the size where taxes may be a consideration.

b. Alternative tax clauses might be designed as follows:

(1) One clause might provide that estate taxes payable from propertyinterests includible in the estate but passing outside of probate will be paidby the recipients of such interests, and taxes passing under the will will bepaid from the residuary estate. This clause may, however, be difficult toadminister.

(2) A tax clause might provide that taxes shall be paid from the residue,but only such portions of the residuary estate which do not qualify for themarital deduction. Such provision might read as follows, "I direct that allestate, inheritance, transfer, succession and other estate taxes (including anyinterest and any penalties with respect to such tax) imposed by reason of mydeath, in respect of property passing under this will, shall be paid from theresidue of my estate. All such taxes imposed in respect of property passingoutside of this will shall be apportioned against and payable by the personsto whom such property is paid, or for whose benefit such property is held."

8. A provision in the will requiring that the estate taxes be paid out of the non-maritalresiduary share should be explicit. In one case, the will provided that estate taxes wouldbe paid out of the nonmarital assets, "... unless in the best business judgment and solediscretion of the executor, such taxes could be more prudently paid from any assets of myestate without respect to what is or is not included in the Marital Trust created by this myLast Will". In that case, the executor actually paid the estate taxes out of non-marital trustassets, and not from the marital share. However, the Tax Court, as affirmed by the TenthCircuit, reduced the marital deduction by the entire amount of the estate tax. The Courtruled that the value of the marital bequest had to be reduced by the potential liability "forall the death taxes" that might have been assessed. The Court applied the test at the time



of death of the decedent, and indicated that a potential reduction of the marital deduction isnot affected by the later events showing the actual payment of the tax was made out of thenon-marital share. Wycoff's Estate v. Comm'r of Internal Revenue, 59 TC 617 (1973)aff'd sub nom. Estate of Wycoff v. C.I.R., 506 F2d 1144, 74-2 US Tax Cas P 13037 (10thCir 1974). But see Patterson v. United States, 181 F3d 927, 930 (8th Cir 1999).Subsequentto the Wycoff decision, the IRS ruled that discretionary authority given to an executor topay estate taxes from a marital bequest, even if such taxes were paid from other property,causes reduction of the allowable marital deduction by the entire amount of estate taxespayable. IRS TAM 7827008 (IRS TAM Mar. 24, 1978)

9. In Estate of Miller, 230 Ill App 3d 141, 595 NE2d 630 (1992), the will of asurviving spouse, in whose estate a substantial QTIP was included, contained a provisiondirecting the personal representative to pay all debts "without reimbursement orcontribution, all estate taxes...". The Court held this language was sufficient to exoneratethe QTIP trust from paying its share of taxes, even when this meant abating certain specificdevises otherwise payable from the probate estate. But see In re Estate of Klarner, 113 P3d150, 156 (Colo 2005).

F. Generation Skipping Transfer Tax.

1. The generation skipping transfer tax (the "GST" tax) is a tax assessed on transfersof property from a transferor to beneficiaries who are in a generation more than onegeneration below that of the transferor. The purpose of this tax is to prohibit the ability ofwealthy taxpayers to transfer property to beneficiaries who are in generations more thanone generation below that of the transferor, so that an estate tax would otherwise beskipped.

2. GST's generally occur in one of two ways: either an outright gift is made to a personwho is more than one generation below that of the transferor ("a skip person"), or a transferis made in trust or in an equivalent trust fashion so that an income interest may be payableto a person who is one generation below the transferor, but distributions of principal will bemade at some time in the future to a skip person.

a. Direct Skips. A direct skip is a direct transfer from a transferor to a skipperson or to a trust of which all beneficiaries are skip persons.

b. Taxable Distribution. A taxable distribution occurs when a distributionof principal is made from a trust to a skip person.

c. Taxable Termination. A taxable termination occurs when a trustterminates, and the principal of the trust is payable to one or more skip persons.

3. A complete discussion of GST's is well beyond the scope of this outline.However, a basic understanding of the general rules will assist the practitioner indeveloping an understanding of the considerations involved when potential GST's are



included in the planning process. In order to develop even a basic understanding of theGST tax problem involved in determining a method of tax apportionment, it is essential toat least understand the following rules:

a. The GST tax is a flat rate equal to the highest marginal estate and gift taxbracket applicable at the time the transfer is made. As of right now, the highest taxrate is 40 percent. Valuation dates differ depending upon when a transfer is madeor, in many cases, whether a taxable termination or taxable distribution is made.The key, however, is that the highest existing federal estate tax rate becomes theonly tax rate applied for GST tax purposes. In other words, the GST tax is thatwhich would be assessed if the property were included in the estate of the personwhose generation was skipped at the highest then existing estate tax bracket(currently 40 percent). IRC §2061.

b. For the 2015 calendar year, each transferor is entitled to a $5,430,000.00exemption against the GST tax. If planned appropriately, a husband and wifecould take advantage of generation skips totalling $10,860,000.00 and escape GSTtaxes.

c. Gifts which are excluded for gift tax purposes either as gifts of $14,000.00or less per donee per annum under IRC §2503(b) or related gifts for medical andtuition payments under IRC §2503(c) are exempt from GST taxes.

d. IRC §2603 provides that the liability for tax depends upon whether a directskip ("DS"), taxable distribution ("TD"), or taxable termination ("TT") is made.

(1) With respect to a TD, the tax imposed under §2601 is paid by the"transferee", i.e., the person who receives the actual distribution from thetrust or trust substitute.

(2) In the case of a TT, or in the case of a DS which is made from a trust,the GST tax is paid by the Trustee, not the recipient of the property.

(3) With respect to a DS (other than a DS from a trust), the transferorpays the tax.

(4) No matter who bears the responsibility for tax, IRC §2603(b)provides that unless the governing instrument otherwise directs pursuant toa specific reference to the GST tax, then the GST tax is charged against theproperty constituting the transfer. This differs from many of the rulesdiscussed earlier in this outline dealing with reimbursement directly fromthe estate of the decedent. The law specifically provides that the propertysubject to the GST tax itself is the property from which the tax is exacted.There is no other provision in Oregon law which would supersede thisprovision, inasmuch as the GST tax is not a "tax" as defined under ORS



Section 116.303(5). This means that in the event a testator provides thattaxes shall be paid from the residue, and if the testator does not specificallyidentify GST taxes, then it is likely that the federal statute will prevail. Todate, however, there is no Oregon case directly on point. The practitionershould evaluate the potential GST taxes in each case and, if those taxes mayoccur, provisions regarding the payment of such tax should be evaluated.

4. The regulations under the GST tax contain a number of rules governing the timing of theallocation of the $5,430,000.00 exemption, rules for automatic allocation of the exemption, andthe procedure for making allocation of the exemption. See 57 FR 61356-01 and 57 FR 61353-02;but see Announcement 93-57 Generation-Skipping Transfer Tax; Correction, 1993-15 IRB 12(IRS ANN 1993).

a. With respect to lifetime transfers which are DS's, the regulations reflect therule under IRC §2632(b), that the transferor's unused GST exemption isautomatically allocated to the transfer. If he or she chooses, the transferor canelect out of the allocation.

b. With respect to a lifetime transfer which is not a DS, allocation of theexemption is made on Form 709. 26 C.F.R. § 26.2632-1(b). The Regs. furtherprovide that allocation of the exemption may be made by formula set forth in thegoverning instrument. With respect to wills and trusts, a formula requiringallocation of the exemption to result in an inclusion ratio of zero will be acceptable.

c. 26 C.F.R. § 26.2632-1(d) provides that at death, the executor can allocateunused GST exemption on the Federal Estate Tax Return, filed within nine monthsof date of death. Any unused GST exemption is allocated pro rata first to DS'soccurring at death, with the balance being allocated pro rata to trusts with respect towhich a TT may occur, or from which a TD may be made. There are certainlimited exceptions to this rule.

5. In the planning process, the practitioner must determine how the GST tax, if any,should be allocated. If the transferor wishes to allocate GST tax in a method other thanthat set forth in the statute, he or she may be able to do so by specifically allocatingexemption to some gifts and not others. This must be done, generally, by way of anaffirmative act or direction in the instrument. If the transferor wishes to allocate GST taxin a method which is most equitable at the time the tax is incurred, then certain drafting tipsshould be followed:

a. If a trust is involved in the estate plan, the Trustee should be authorized todivide a single trust into separate trusts, giving authority to establish one trust withan inclusion ratio up to one and the second trust with an inclusion ratio of zero.This will enable the Trustee or Executor to allocate the GST tax exemption to onetrust, and not the other.



b. If a marital trust at the death of the first spouse is exempt from estate andGST tax, then the tax allocation clause in the will or trust should provide forpayment of estate tax at the death of the second spouse from a source other than thattrust, so long as other funds are available and the result would be consistent with thedispositive scheme.

c. The will or trust should include a provision empowering the Executor toallocate GST exemption on a non-prorata basis.

6. If the first spouse to die did not exhaust his or her GST exemption on lifetimetransfers, then to the extent the exemption is not allocated to non-marital gifts, there shouldbe provisions for a reverse QTIP trust to be created. Remember, the portability rules donot apply to GSTs. A reverse QTIP trust is, in all respects, identical to a QTIP trust,except that for GST tax purposes, the first spouse to die is deemed to be the transferor. Inthis way, the full exemption available to the first spouse is allocated to the reverse QTIPtrust, with the balance of the QTIP trust being deemed to be property transferred by thesecond spouse at his or her subsequent death. The second spouse will then use his or herown GST exemption against the property inside the normal QTIP trust. A reverse QTIPwill generally be established one of three ways:

a. The will or trust may authorize the Executor to create a reverse QTIP trust;

b. The will or trust may allow the surviving spouse to create, through use of adisclaimer, a reverse QTIP trust upon the first spouse's death; or

c. The will or trust may direct the Executor to create the reverse QTIP trust.

7. The will or trust instrument should authorize the Executor to fund the reverse QTIPby using a pecuniary formula clause, which should define the amount of the reverse QTIPas the amount of exemption less

a. Allocations of the exemption made to lifetime transfers;

b. Allocations made by the Executor to other transfers occurring at death.

8. The practitioner should include a provision protecting the reverse QTIP trust or anyother trust which qualifies for the GST tax exemption against allocation of taxes andexpenses of administration.

9. For an excellent evaluation and analysis of the establishment of a reverse QTIPtrust and sample language for will and trust documents, see ¶16,801, Planning a MarriedCouple's Estates to Make Maximum Use of Both Spouses' GST (Generation-SkippingTransfer Tax) Exemptions, RIA Estate Planning & Taxation Collection.



G. Revocable Living Trusts.

Quite often, practitioners are engaged in drafting revocable living grantor-type trusts fortheir clients, which contain testamentary provisions at death. These trusts are drafted for anumber of reasons, most often probate avoidance, privacy and avoidance of ancillary probates. Aproperly planned estate, when using a revocable trust, also includes a pourover will, making surethat all of the decedent's assets are payable to the revocable trust following the decedent's death, tothe extent that they were not transferred to the trust at an earlier time. In some cases, a revocabletrust may be established to hold only certain specific assets, with the bulk of the decedent's estatebeing held outright, for distribution pursuant to the terms of the will. A pourover will is oftenused in these situations as well, to simply transfer the decedent's estate assets to the trust. Thedispositive provisions of the estate plan will be contained in the trust.

1. Although ORS §§116.303 to 116.383 deal with allocation absent contraryprovisions in wills, there is no corresponding provision in the statute to deal with revocableliving trusts.

2. The problem which the practitioner must face in drafting these documents restsupon an analysis of the fund from which the taxes should be paid. There are a number ofalternatives:

a. Should taxes be apportioned among all beneficiaries of the decedent'sestate, receiving assets from both the revocable trust and the will?

b. Should taxes be apportioned only to the estate?

c. Should taxes be apportioned only to the revocable trust?

d. If taxes are apportioned only to either the will or the revocable trust, shouldthey be payable from the residue or apportioned among the beneficiaries of thatparticular document?

e. It is essential to keep in mind that whatever alternative is chosen, the willand trust must have consistent apportionment language. See Construction, andApplication of "Pay-All-Taxes" Provision in Will, as Including Liability ofNontestamentary Property for Inheritance and Estate Taxes, 56 A.L.R.5th 133(Originally published in 1998).

3. Generally, the determination as to where taxes should be apportioned is based uponthe facts and circumstances in each case. For example, if the revocable trust only containsland in another jurisdiction and provides for distribution in equal shares to the decedent'schildren, and the accompanying probate estate contains the remaining assets which will bemore than sufficient to pay taxes, it would be appropriate to charge such taxes to thedecedent's estate, and not the revocable trust.



a. On the contrary, if a revocable trust comprises the bulk of the assets of thedecedent's estate, and the pourover will has been drafted only as a devise to sweepup any assets which might escape transfer into the trust, a provision in the willrequiring taxes and expenses of administration to be apportioned to the decedent'srevocable trust would be appropriate.

b. In all of these cases, the trust should contain a provision authorizing thetrustee to purchase assets from the decedent's estate at their fair market value, sothat in the event taxes must be paid from the decedent's estate, there is a mechanismto move assets from the will to the trust, in exchange for cash of the trust, to providethe liquidity necessary to pay such taxes. Because the basis in the assets is steppedup to fair market value at date of death, a sale from the estate to the trust at fairmarket value at date of death should incur little or no tax.

4. In the event a method of apportionment different from the scheme set forth underOregon law is chosen by the client, then any contrary provisions should be included in theclient's will, as well as the trust. Since the statute does not specifically recognize the useof trusts as a method of circumventing the apportionment laws, including apportionmentlanguage in the trust in contravention of statutory apportionment could jeopardize theestate's apportionment plan. Using words of apportionment in the will of the decedentshould take care of this problem.

a. This may create additional problems. Each time a trust is amended to adda new specific bequest or change the method of apportionment, it is likely that acodicil to the will may also be required to reflect any additional changes to thepreconceived apportionment plan.

b. There is no guarantee that the trust can supersede Oregon statute. It islikely that a disgruntled beneficiary may challenge the trust if no conformingapportionment schedule appears in the will. To circumvent this problem, onemight include a provision in the will to the effect that the taxes will be apportionedin accordance with the terms of the revocable living trust of the decedent.However, inasmuch as the revocable living trust is not executed with testamentaryformalities, the trust and any subsequent amendments may not conform to thedefinition of "will" set forth in the Oregon Revised Statutes. Probably the bestmethod of protecting against this problem is including the provision discussedabove in the will and then duplicating in the will the apportionment plan set forth inthe trust instrument. It would be important to ensure that the apportionmentlanguage appears as well in the trust.

5. In cases where problems are anticipated, it may be wise to force a probate of thewill to take advantage of Oregon law. This is based on the fact that the law confers uponpersonal representatives certain collection rights against beneficiaries to whom taxes maybe apportioned, as discussed above. The Internal Revenue Code, as well, confers rights ofreimbursement to the personal representative under IRC §§2205-2207B. In addition, the



personal representative is in the best position to secure an order of the probate courtapproving the tax apportionment scheme. In the event the assets remaining in the estateare insufficient to pay such taxes, then the personal representative would have the right tocollect from the trustee of the revocable living trust such sums as are necessary to pay theremaining taxes.

a. A corresponding provision should be included in the living trust,authorizing the trustee to distribute assets from the trust to the personalrepresentative for the payment of such taxes. In the event that the assets of theestate are of the type and quality that the personal representative would wish tohave preserved for the benefit of the trust beneficiaries, the provision authorizingsale of assets to the trust, in exchange for the trust's liquidity, would take care of theproblem.

b. In the alternative, a provision could be included in the will providing that inthe event the assets of the estate are of such a type and variety that it would beimprudent to liquidate them to pay the taxes and expenses of administration leviedupon the estate, the personal representative shall have the right, in his discretion, toseek such sums from the trustee as are necessary to pay such taxes. In this case,the trust should contain language authorizing the trustee to pay to the personalrepresentative the trust's appropriate share of the tax.

c. The drafter must be careful in these situations to ensure that taxes payable,whether from the estate or from the trust, shall not be chargeable against the maritalor any other exempt share.

6. In all of the situations set forth above, the primary consideration for the fiduciary iswhether taxes shall be paid from the residuary share of either the estate or the trust, orwhether taxes shall be apportioned among all beneficiaries. Once that determination ismade, a simple computation regarding the expected tax payable and the proposed effectupon beneficiaries will assist the practitioner in advising the client as to the effect of eachalternative. This alternative can then be incorporated into the language of both the willand trust.

H. Special Use Valuation Recapture.

Under IRC §2032A, certain property used in the trade or business, generally associatedwith farming and ranching, can be valued for estate tax purposes at its actual current use, ratherthan its highest and best use. This reduction in value can be as much as $1,100,000.00. IRC§2032A(a)(2).

1. Under §2032A(c), an additional estate tax is assessed if, within ten years after thedecedent's death and before death of a qualified heir, the qualified heir disposes of anyinterest in the property or ceases to use the property for a qualified use.



2. Under §2032A(c)(5), the qualified heir (the person who receives the property) ispersonally liable for any additional tax due.

3. On its face, this appears to cover the apportionment problem. However, the realproblem manifests itself in the fact that the estate tax benefit of electing special use valueunder §2032A will often inure to someone other than the qualified heir. If, at a subsequenttime, the qualified heir ceases to use the property in its qualified use, then the qualified heiris subject to payment of the tax. Therefore, if any qualified use property exists at the timethe estate plan is prepared, one of two methods should be taken into consideration:

a. The will or trust instrument should allocate the benefit of the reduction invalue directly to the qualified heir, and reduce his or her otherwise allocable taxburden proportionately; or

b. The will or trust instrument should provide that any recapture of tax if theproperty ceases to be used in a qualified use will be allocable not to the qualifiedheir but to the beneficiaries who inured to the benefit of the tax reduction in the firstplace.

(1) There appears to be no law directly on point authorizing a testator tooverride the application of §2032A(c)(5).

(2) Therefore, it is probably wise to provide in the will or trustinstrument that the qualified heir has the right to full indemnification fromthe beneficiaries who initially received the tax benefit, in the event thequalified heir is charged with the additional tax. See Klug, The Effect ofSpecial Valuation on Estate Tax Apportionment: A Plea for UniformLegislation, 1 Prob. & Prop. 6 (March/April 1987).

4. An additional problem under §2032A presents itself in the case of partial interests.If the qualified use property is placed into a trust, with the life tenant being the partycausing recapture, it appears under the apportionment statutes that the corpus of the trustwould bear the tax, causing inequity between the life tenant and the remainderman. Thisshould also be closely evaluated in drafting any estate plan in which qualified use propertymay be included.

I. Oregon Natural Resource Credit Recapture. Oregon HB3201, enacted on July 31,2007, introduced the Oregon Natural Resource Credit into the law. HB3618, passed in 2008, andHB2541, passed in 2011, introduced substantial changes to the Oregon Natural Resource Creditlaw.

1. Basically, the law provides that to the extent an Oregon decedent owns naturalresource property, which is designated either as farm use property or one or more farm usehomesites related to the real property, or forest land or one or more forest land homesites not to



exceed 5,000 acres, or for fishery operations, then a credit against Oregon Estate Tax may beavailable.

2. The law provides the formula for calculating a credit against Oregon Estate Tax fora percentage of the adjusted gross estate that is claimed is Natural Resource Property. Themaximum amount is capped at $7.5 million. ORS 118.140(1)(b).

3. It is interesting to note that the Natural Resource Credit is available for Oregonpurposes even if the property passes to the surviving spouse and a marital deduction is claimedagainst the property on the federal return.

4. Even though a discussion of the Oregon Natural Resource Credit is well beyond thescope of this outline, a similar issue to that existing with IRC§ 2302A also exists with respect tothe Oregon Natural Resource Credit.

a. If, pursuant to the terms of the governing instrument, taxes are to be paidfrom the residue, then the residual beneficiaries will actually inure to the benefit of the NaturalResource Credit.

b. However, ORS 118.140(9)(a) provides that if a qualifying heir does notcontinue to own and operate the natural resource property for five out of the eight years followingthe decedent’s death, then the credit is recaptured. The tax is not paid by the residualbeneficiaries who inured to the credit; instead, it is paid by the qualified heir.

c. Therefore, it is important when drafting to take advantage of the OregonNatural Resource Credit, to evaluate whether the beneficiaries who inured to the benefit of thecredit or the qualified heirs should pay the recapture tax. If the testator includes a residuaryapportionment clause and the beneficiaries of the residue are not the beneficiaries of the naturalresource property, and if the testator wants the residual beneficiaries to pay any recapture tax, thena condition of their bequest should be the obligation to pay any recapture tax.

J Problem Areas.

1. In many instances, a properly drafted buy-sell agreement can establish a justifiablefederal estate tax value for closely held corporate stock.

a. In some instances, the owner of stock in a closely held corporation mayenter into a buy-sell agreement requiring the executor to sell his or her stock at fairmarket value. If the IRS accepts this provision, there should be no problem.

b. However, sometimes taxpayers become "piggish", requiring repurchase at areduced fair market value. In the event the IRS refuses to accept the buy-sellagreement as binding for estate tax purposes, or if the buy-sell agreement does notcontain restrictions which the IRS deems acceptable in establishing valuation, the



IRS could refuse to accept the buy-sell agreement as binding. In this case, bothmarital and charitable deductions could be adversely affected.

(1) If the disparity between the amount the estate receives for purchaseof the stock and the estate tax attributed to the fair market value of the stockis large enough, the residuary estate may be insufficient to pay expenses andestate taxes.

(2) This could have the effect of requiring charitable bequests and/orthe marital deduction to bear their share of the additional tax. This has thefurther effect of reducing the charitable and/or the marital deduction, whichfurther increases tax.

2. Under IRC §401(a)(11), the non-participant spouse in a retirement plan has theright to receive a spousal annuity under the Retirement Equity Act of 1984. If the spousefails to consent to override this provision, and if the participant dies first leaving adisposition from the retirement plan which does not conform to the §401(a)(11) annuityrequirements, the non-participant spouse is deemed to make a gift. This gift will serve toreduce the unified credit otherwise available to the non-participant spouse and may, atsome time, trigger additional tax. Care should be taken to ensure that if this occurs,provisions for the allocation of potential federal estate taxes should be taken into account.

3. IRC §2002 requires that the tax imposed under the Internal Revenue Code shall bepaid by the executor. If any portion of the estate tax is paid by a recipient of non-probateproperty included in the gross estate, that person is entitled to reimbursement from theexecutor. The executor then has the right to secure reimbursement of tax from therecipients of the property under IRC §§2005-2007B. It is important in planning for taxapportionment to provide adequate funds for the executor to pay the tax initially, ratherthan having the executor needlessly waste time in securing funds to pay the tax prior to thetime reimbursement is sought. The only exception to this rule is IRC §2210, whichpermits voluntarily assumption of the obligation to pay tax by a qualified employee stockownership plan or a qualified worker owned cooperative, relieving the executor of primaryresponsibility. This only applies to the extent that the plan administrator agrees to executean agreement under §2210(e), which appears to result in a gratuitous payment of the taxesotherwise payable from the estate. See Recent Cases Narrow Scope of Executor'sPersonal Liability for Estate Taxes, 7 Est. Plan. 2 (1980).

a. The executor, once tax is paid, can rely upon the different transfereeliability rules discussed above.

b. The executor can also rely upon IRC §6324(a)(2) establishing a lien againstproperty from which the personal representative may secure reimbursement, andIRC §6901(a)(1), dealing with transferee liability.



4. Previous discussions in this outline have presumed that the marital deductionshould be preserved at all costs. However, in most cases there has not been adetermination as to whether the marital deduction is actually a benefit solely for thesurviving spouse or is a benefit instead for the estate in general.

a. The initial purpose of the marital deduction was to provide equalitybetween common law and community property states, which seems to argue infavor of the fact that the marital deduction is a benefit conferred upon the entireestate.

b. However, the purpose of the intestate or forced heir marital share is toprotect the surviving spouse, which arguably means that the marital deductionshould be for the sole benefit of the surviving spouse.

c. If the marital deduction benefits the entire estate, then the tax attributable toother assets of the estate should in some way be apportioned to the marital share.

d. If the marital deduction benefits the surviving spouse only, then it isappropriate to preserve the marital deduction and apportion taxes away from themarital deduction at all costs. Jeffrey N. Pennell, Apportionment Can Make TaxPayment More Equitable, 22 Est. Plan. 3 (1995).

5. What happens if Congress finally enacts a tax on capital gains at death or anadditional estate tax on appreciated assets? Will this be an estate tax or an income tax?Although these questions are unanswered, it may be wise to contemplate the eventualpresence of such an act at the time a particular client dies. Including provisions in thegoverning instrument to take into account any potential capital gains or appreciation taxesat death may avoid significant problems at a later time.

a. If all else fails, a provision in the governing instrument authorizingallocation of the tax in accordance with the Oregon Apportionment Laws, asthough any such capital tax or appreciation tax were identical to an estate tax,should suffice.

b. Be careful, however, if in the enactment of such a tax Congress refuses toprovide exemption to the extent assets pass to a surviving spouse or charity. Inthis case, the treatment of the tax as an estate tax may cause the marital deduction orcharitable deduction to be reduced, thereby increasing estate taxes.

6. One of the most difficult areas in tax allocation deals with apportionment inmultiple state estates, and how the rules of one state may be enforced against property orbeneficiaries in another state.



a. Under the Doctrine of Equitable Conversion, personal property is deemedto be located in the state of domicile of the decedent. Real property, however, isdeemed to be located in the state of its situs.

b. When dealing with multiple state estates, the will or governing instrumentshould contain specific apportionment provisions, so that conflicts between statelaws will not prevail. In these situations, make sure that the governing instrumentsupersedes all provisions of state law and provides for a uniform method of taxapportionment.

c. For excellent analysis of these issues see Scoles, Estate Tax Apportionmentin the Multi-State Estate, 5 Inst. On Est. Plan. ¶700 (1971).

7. Special consideration should also be given to the provisions of IRC §303. Underthis Section, certain favorable income tax treatment is given to the estate if closely heldsecurities are redeemed to pay expenses of administration or estate taxes.

a. However, the dividend avoidance benefit of IRC §303 is only available ifthe owner of the stock in the closely held corporation also is the person or entityagainst whom the tax is assessed.

b. If the estate plan contemplates taking advantage of the provisions of IRC§303, then the practitioner should make sure that the tax is allocated to theappropriate party. In many cases, this will be the estate itself, which will transactthe §303 redemption prior to distribution of assets to beneficiaries.

8. Special consideration must be given to inter vivos tax planning devices which may"go bad" in the future. For instance, presume an individual creates an irrevocable lifeinsurance trust, ostensibly for the purpose of removing the life insurance from thetransferor's estate. The transferor then dies within three years of the transfer, and asignificant amount of insurance owned by the trust becomes taxable in the transferor'sestate.

a. In these cases, it is important to include a provision in the life insurancetrust authorizing the purchase of assets from or the lending of money to thedecedent's estate or living trust, so that funds can be allocated to the source uponwhich the burden of tax rests.

b. Additional provisions authorizing indemnification for any taxes attributableto property in the life insurance trust may also be helpful in this situation.

c. Be sure to remember that in these cases, strong consideration should begiven to a provision in the trustor's will specifically authorizing apportionmentagainst the trust, if taxes are incurred by the trust.



K. Tax on Adjustable Taxable Gifts.

Under IRC §2001(b)(1)(B), the federal estate tax is computed based upon propertyincludable in the estate at death and the value of adjusted taxable gifts made prior to death. Theterm "adjusted taxable gifts" means the total amount of taxable gifts made by the decedent afterDecember 31, 1976, other than those which are already includable in the gross estate. Any planfor potential apportionment of estate taxes should take into account the adjusted taxable gifts of thedecedent at the time the estate plan is developed.

1. If an adjusted taxable gift exceeds the amount of the unified credit (i.e., gifts inexcess of $5,430,000.00 plus any per donee exclusion), then gift tax is immediatelypayable upon those gifts at the time of the gift. The apportionment question in thatsituation really depends upon the intent of the donor. If the donor wants the donee to paygift tax, the donor will probably make a "net gift", which, essentially, is a gift less the valueof the gift taxes attributable thereto.

2. On the other hand, the donor can pay the gift tax himself or herself.

3. What happens, however, with adjusted taxable gifts totaling less than$5,430,000.00 which were made by the testator during lifetime, but which are includable inthe testator's estate at death? If the testator's taxable estate exceeds $5,430,000.00, thenthere will be a tax attributable to the adjusted taxable gifts made prior to death. Thepractitioner should take these gifts into account in determining whether to apportion taxesto those gifts or, in the alternative, to assign the tax attributable to those gifts to some otherproperty, presumably the residuary estate at death.

a. If the decision is made to apportion tax to the adjusted taxable gift, then thepractitioner or the donor should take the steps necessary at the time of gift to advisethe donee that a tax will eventually be attributable to that gift.

b. This can often be cumbersome and unworkable. Care should be taken inconnection with this planning.

4. The same problem will often arise in situations where even though a taxable giftwas made prior to death, the size of the estate at the time of death, coupled with theadjusted taxable gift, makes the tax attributable to the prior taxable gift substantially morethan the gift tax paid at the time the gift was made. Should additional estate taxes beallocated to the beneficiary of the gift at that time? These are questions which the donorand his or her counsel must evaluate at the time the estate plan is conceived or when the giftis made.

5. Another problem has arisen in recent years regarding adjusted taxable gifts andtheir treatment by the IRS. Although the IRS may accept a Gift Tax Return as filed at thetime a gift is made, the Service reserves its right to revalue the gift as an adjusted taxablegift at the time of the donor's death. For instance, if a donor makes a gift of real property



valued at $100,000.00 and later dies, the IRS reserves its right to revalue that gift as anadjusted taxable gift for federal estate tax purposes. If the Service determines that theactual value of the property was $200,000.00, then even though the Gift Tax Return statutemay have expired, the gift can still be revalued as an adjusted taxable gift for federal estatetax purposes. Who should pay the tax in this instance?

a. Again, it depends upon the intent of the donor, if the donor even consideredthis situation.

b. It seems logical that any additional tax generated as a result of inclusion ofthe adjusted taxable gift at a higher value should be apportioned to the gift. ORS116.313 seems to provide that the additional tax should be apportioned to thedonee, and not to the residuary estate. A standard apportionment clause whichprovides that all taxes and expenses of administration shall be charged to theresidue would supersede this provision and allocate the tax to the residuary estate.

c. If, at the time a gift is made, there exists a question regarding whether thegift tax value of property will be sustained as an adjusted taxable gift, considerationshould be given by the practitioner and the donor at the time of the gift and any latertestamentary instrument regarding this issue.

L. Disclaimers.

As discussed in the preceding chapters in this outline, disclaimers are a valid and effectivedevice for correcting problems or taking advantage of certain tax or other benefits following atestator's or trustor's date of death. However, no disclaimer should be undertaken without firstexamining the effect of the disclaimer upon the apportionment of taxes and expenses ofadministration.

1. In drafting alternatives for disclaimers, such as marital deduction disclaimer anddisclaimer bypass trusts, care should be taken to ensure that if a disclaimer is made, theeffect of the disclaimer should not cause federal estate tax to be apportioned to propertyother than that originally considered for apportionment.

2. Take, for example, the effect of a tax apportionment clause allocating all taxes tothe residuary share, and allowing a portion of the share to be disclaimed into a trust whichqualifies for the marital deduction. Any such disclaimer, although creating a transferwhich would otherwise qualify for the marital deduction, may be academic, inasmuch asthe marital deduction would be subject to limitation by taxes and expenses ofadministration directly allocable to the property otherwise qualifying. This could upsetthe plan. A clause in the governing instrument allocating all taxes and administrationexpenses to be charged against the share of the estate which does not qualify for the maritaldeduction, even in the event of a disclaimer, should take care of this problem.



3. However, special care should be given when adding a provision such as the onedescribed above to ensure that a heavier burden of taxes and administration expenses donot fall upon a beneficiary who is not receiving enough property to pay such costs.

VI. EQUITABLE ADJUSTMENTS

A. The Basic Dilemma.

In many cases, a decision by a fiduciary to determine whether or not an item is chargeableas a deduction for income tax purposes or, instead, is deducted for estate tax purposes, will have asignificant effect upon the beneficiaries involved. This is just one situation in which the doctrineof equitable adjustments has come into play. Although the concept of equitable adjustments isrelatively new, with the increasing awareness of practitioners and the alternatives available withrespect to tax allocation, the determinations made by fiduciaries, although appropriate for taxpurposes, may not be equitable under local law.

B. Basic Analysis.

An in-depth discussion of the doctrine of equitable adjustments is inappropriate forpurposes of this outline on tax apportionment. However, it is important to note that in makingcertain tax allocation decisions in a decedent's estate, the ramifications of such decisions can befar-reaching.

1. For example, when a personal representative elects to take an expense ofadministration as a deduction against the estate tax return, as opposed to the income taxreturn, or vice versa, this decision affects the net amount receivable by the appropriatebeneficiaries of either the income or the principal of the estate. Probably the most famouscase in this area is In re Warms' Estate, 140 NYS2d 169 (Sur 1955). In the case, theexecutor elected to treat estate administration expenses as income tax deductions, ratherthan estate tax deductions. The election had two effects:

a. First, the election reduced the amount of the estate's taxable income. Thishad the effect of increasing the net amount of distributable income to the incomebeneficiaries.

b. Second, the amount of estate taxes, which were chargeable to corpus, wasincreased by virtue of the fact that the deduction was not taken on the federal estatetax return. This had the effect of reducing the amount distributable to theremaindermen.

c. The court determined that it was inappropriate for the income account toreceive the tax benefit, since the expenses were actually paid from the principalaccount. The court ruled that the income account should reimburse the principalaccount for the amount of increase in estate taxes which resulted from using theexpenses as an income tax deduction. The Warms decision has been consistently



followed in other jurisdictions. See Blattmachr, Jonathan, The Tax Effects ofEquitable Adjustments: An Internal Revenue Code Odyssey, 18 Miami Inst. OnEst. Plan. Ch. 14 (1984).

2. In some situations, where conflicts over tax elections arise, it may be appropriate toprovide in the will that the fiduciary is authorized to make the election which results in thelowest tax, and to divide the benefits of such election to make the parties whole. This,unfortunately, has significant tax effects.

a. If the reimbursement is deemed to be a reimbursement of income tax, thenthis provides additional taxable income to the person or entity being reimbursed.

b. The issue is more clouded when one of the beneficiaries is the survivingspouse or marital deduction trust, or is a charity.

c. Perhaps the best approach would be to draft an instrument which prohibitsall equitable adjustments where the overall tax effect would be adverse. This isbest done by providing that no equitable adjustments shall be made, to the extentthe effect of the equitable adjustment would be to cause the estate tax maritaldeduction or charitable deduction, which might be allowed if no adjustment weremade, to be lost in whole or in part. To the extent that the equitable adjustmentcauses corpus from either a marital or charitable bequest to be allocated to a taxableentity, the marital deduction or charitable deduction may be reduced. Theopposite result occurs if property passing to a beneficiary other than the spouse or acharity ends up passing to the spouse (or marital trust) or charity, incurringadditional marital or charitable deductions.

d. For an excellent discussion of the current law regarding equitableadjustments and the effect which such equitable adjustments have on estate taxesand income taxes, see Blattmachr, supra.

VII. ABATEMENT

In some cases, the assets of an estate are insufficient to pay all claims, expenses, anddevises in full. This is generally true when the costs of administration and related claims againstthe estate consume a substantial share of the estate. Under ORS 111.005(1), the term "abate"means to reduce a devise on account of the insufficiency of the estate to pay all claims, expenses,and devises in full.

A. General Rules.

The general rules of abatement under Oregon law appear at ORS 116.133. Pursuant tothat provision, if the will expresses an order of abatement, or if the testamentary plan or the expressor implied purpose of a devise would be defeated by statutory abatement, then shares of



distributees will abate as may be found necessary to give effect to the testator's intent. In otherwords, if the testator's intent is known, shares of the estate will abate consistent with such intent.

B. Special Situations.

ORS 112.405(5) provides that a pretermitted child has the right to take his or her shareeither from the other children, if any are living, or from the testamentary beneficiaries other thanthe decedent's children, if the decedent left no children. The statute goes on to provide thatinterests of those beneficiaries will abate proportionately, so as not to upset the character of thetestamentary plan.

C. General Order of Abatement.

Other than these two exceptions, the shares of distributees abate without any preference orpriority as between real and personal property in the following order under Oregon law:

1. Property not disposed of by the will;

2. Residuary devises;

3. General devises;

4. Specific devises.

D. Abatement Within Classes.

Abatement within each of the classifications set forth above is in proportion to the amountsof property each of the distributees would have received had full distribution of the property beenmade.

E. Tangible Personal Property.

Recipients of tangible personal property generally are not subject to abatement, unless thetangible personal property is used in trade, agriculture or other business or unless the particulardevise of personal property forms a substantial amount of the total estate, and the court specificallyorders contribution because of the devise.

F. Sale of Specifically Devised Property.

If any particular property subject to a devise is sold or used incident to administration, thenthe statute provides that abatement may be achieved by appropriate adjustments in or contributionsfrom other interests in the remaining assets of the estate. ORS 116.133(6).



G. Planning for Abatement.

Often, the will does not provide for abatement of bequests in order to pay claims andexpenses of administration. In the absence of such a provision, these costs will be paid first fromintestate property subject to administration and then from the residue of the estate. If these assetsare insufficient, then the abatement scheme set forth above will prevail.

1. It is important, then, to consider from which share of the estate these expenses andclaims should be paid. Probably the easiest planning device is to ensure that sufficientassets remain in the residue to pay these expenses and claims. If so, then reliance upon theOregon statute would be appropriate.

2. If, however, certain large specific devises or general devises exist in a will, it maybe appropriate to provide that these assets will bear a proportionate share of the tax, basedupon a preconceived equation.

H. Determine Intent.

The key, as in the case of apportionment of estate taxes, is first to determine the client'sintent. Once intent is determined, and if a reasonable estimate of the amount of expenses andclaims can be made, then appropriate planning can be completed and the provisions of the will ortrust can be drafted to accommodate the plan.



Chapter 2

Estate Planning and Administration with S Corporations1

amelia heath

US Trust, Bank of America Private Wealth ManagementPortland, Oregon

Jeff Chaidez

US Trust, Bank of America Private Wealth ManagementPortland, Oregon

1 This content represents thoughts of the authors and does not necessarily represent the position of Bank of America or U.S. Trust. Neither U.S. Trust nor any of its affiliates or advisors provide legal, tax, or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions. Always consult with your independent attorney, tax advisor, investment manager, and insurance agent for final recommendations and before changing or implementing any financial, tax, or estate planning strategy. U.S. Trust operates through Bank of America, N.A., and other subsidiaries of Bank of America Corporation. Bank of America, N.A., Member FDIC. © 2015 Bank of America Corporation. All rights reserved.

Contents

I. Requirements to Make and Keep an S Election. . . . . . . . . . . . . . . . . . . . . . . . . . . 2–1

II. Estate Planning Techniques and Considerations with S Corporations. . . . . . . . . . . . . . 2–6a. Basic Estate Planning—Wills and Revocable Trusts . . . . . . . . . . . . . . . . . . . . 2–6b. Common Estate Planning Techniques and How They Work with S Corporation

Stock. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–6c. Fiduciary Duties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–8d. Treatment of Intangible Assets of S Corporation During Estate Administration . . . . 2–9

III. Income Tax Considerations for Trust and Estate Administration with S Corporations . . . 2–10a. Selecting a QSST vs. an ESBT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–10b. Section 645 Election . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–11c. Allocating Income in the Year of Death . . . . . . . . . . . . . . . . . . . . . . . . . . 2–12d. Family Groups . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–13

IV. S Corporation Dispositions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–13a. Asset Sales (Timing of Asset Sales with Liquidation) . . . . . . . . . . . . . . . . . . 2–13b. Stock Purchases Treated as Asset Acquisitions—IRC § 338(h)(10) . . . . . . . . . . . 2–15c. S Corporation Stock Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–15

Appendix 1—QSST Election Form . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–17

Appendix 2—ESBT Election Form . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–19

Chapter 2—Estate Planning and Administration with S Corporations




I. Requirements to Make and Keep an S Election a. The company may have no more than 100 shareholders. IRC § 1361(b)(a)(A). Spouses

(and their estates) are treated as one shareholder. IRC § 1361(c)(1)(A)(i). Similarly, if individuals are ancestor and descendant (within six generations), have a common ancestor (within six generations), or are spouses or former spouses of such family members, they are treated as one shareholder. IRC § 1361(c)(1)(A)(ii) and (B)(i).

b. S corporations may have no more than one class of stock. IRC § 1361(b)(1)(D). S corporations may have voting and nonvoting stock, so long as there is only one class of stock. IRC § 1361(c)(4).

c. The type of corporation is not listed as an ineligible corporation in Internal Revenue Code section § 1361 (b)(2).

d. All shareholders must be eligible S corporation shareholders. The following types of

shareholders are eligible.

i. Individuals who are either U.S. residents or U.S. citizens. IRC § 1361(b)(1)(B) and (C).

ii. Estates. An estate is an eligible S corporation shareholder. IRC § 1361(b)(1)(B). Generally, it may remain so for a reasonable period of time to conduct administration. It cannot, however, remain in existence and remain an eligible shareholder indefinitely. See, e.g., Old Va. Brick Co. v. Com’r, 367 F2d 276 (4th Cir 1966).

iii. Certain types of domestic trusts. Foreign trusts (defined in IRC § 7701(a)(31))

are ineligible shareholders.

1. Grantor trusts. A “grantor trust” is a trust the assets of which are deemed to be owned by an individual settlor or beneficiary under IRC § § 671-679. A grantor trust may hold S corporation stock. IRC § 1361(c)(2)(A)(i). The deemed owner of the trust’s assets is treated as the shareholder for purposes of eligibility rules. IRC §1361(c)(2)(B)(i). Therefore, the individual deemed to own the trust assets must not be a nonresident alien. Common types of grantor trusts include

a. Revocable trusts during settlor’s lifetime. IRC § 676(a).

b. Trusts in which the settlor has retained an income interest or granted an income interest to his or her spouse. IRC § 677(a).

c. Trusts that grant any party the right, in a nonfiduciary capacity, to reaquire trust assets by substituting property of equivalent value. IRC §675(4)(C).



d. Trusts in which the settlor has retained the power to borrow assets of the trust estate without adequate interest or security. IRC § 675(2).

2. Revocable trusts within two years of death. If the entire corpus of a

revocable trust is includible in the settlor’s estate, then the revocable trust remains an eligible shareholder for up to two years following the settlor’s death. IRC § 1361(c)(2)(A)(ii). Once the eligibility period expires, if the trust retains ownership of the stock, then the trust is treated as the shareholder. Treas Reg § 1.1361-1(h)(1)(ii). The corporation’s S election will terminate if the trust is not then an eligible S corporation shareholder (e.g. whether it has made an election to be a qualified subchapter S trust or an electing small business trust). During the two year period of eligibility, the decedent’s estate is the deemed shareholder. IRC § 1361(c)(2)(B)(ii).

3. Testamentary trusts within two years of receipt of S corporation stock. A testamentary trust qualifies as an S corporation shareholder for two years beginning on the date that it receives the S corporation stock from the decedent’s estate pursuant to the terms of a will. IRC § 1361(c)(2)(A)(iii). A testamentary trust may continue as a permitted shareholder after the end of the two year period by becoming a qualified subchapter S trust or an electing small business trust. See Treas Regs § 1.1361-1(h)(3)(i)(D). The trust is the deemed owner of the stock. Treas Regs § 1.1361-1(h)(3)(ii).

4. Qualified Subchapter S Trusts (QSST). A QSST must meet these

requirements. Whether or not a trust qualifies as a QSST depends on the terms of the trust document and applicable local law. Treas Regs § 1.1361-1(j)(2)(ii).

a. Requirements.

i. All trust income is distributed to a single current income

beneficiary. IRC § 1361(d)(3)(B). That current income beneficiary is considered to be a shareholder for purposes of determining the number of shareholders of the corporation. IRC § § 1361(d)(1)(A).

1. If the trust agreement allows accumulation of

income but all income is in fact distributed, then the trust is not disqualified as a QSST. Rev Rul 92-20, 1992-1 C.B. 301.

2. If a distribution to an income beneficiary satisfies

the settlor’s support obligation to that beneficiary, the trust will cease to be a QSST on the date of distribution because the trust is a grantor trust. Treas Regs § 1.1361-1(j)(2)(ii)(B) and (C). (The



settlor is the deemed owner of the income portion of the trust under IRC § 677(b).)

ii. The single current income beneficiary is not a nonresident alien. IRC § 1361(d)(3)(B).

iii. There is only one current income beneficiary during that

income beneficiary’s lifetime. § 1361(d)(3)(A)(i). The trust may, however, have multiple beneficiaries if the separate and independent share rule of IRC section 663(c) applies. IRC § 1361(d)(3) (flush language).

iv. If any principal distributions are made during the current

income beneficiary’s lifetime, then the distributions are made to that current income beneficiary. IRC § 1361(d)(3)(A)(ii).

v. The income beneficiary’s interest terminates on the

beneficiary’s death or the trust’s termination, whichever is first. IRC § 1361(d)(3)(A)(iii).

vi. If the trust terminates during the income beneficiary’s

lifetime, all trust assets are distributed to that beneficiary. IRC § 1361(d)(3)(A)(iv).

b. Election.

i. The QSST election is made by the current income

beneficiary, not the trustee. IRC § 1361(d)(2)(B)(i).

ii. The QSST election must be filed within two and a half months of when the subject trust receives the S corporation stock (or otherwise becomes an ineligible shareholder) or after the corporation elects S status. IRC § 1361(d)(2)(D). Revenue Procedure 2013-30 provides the method for obtaining relief from an inadvertent late election.

iii. The beneficiary must make an election for each corporation

whose stock is held in the trust. IRC § 1361(d)(2)(B)(i).

iv. A beneficiary’s consent to the corporation’s S election is not a QSST election.

v. A form of election meeting the requirements of Treasury

Regulations section 1.1361-1(j)(6)(ii) is included as Appendix 1. The election must be filed with the IRS service center with where the corporation files its income tax return.



5. Electing Small Business Trust (ESBT)

a. An ESBT is much more flexible with its permissible terms than a QSST, but there are some tax issues with ESBTs that sometimes make them less desirable than QSSTs (discussed below).

b. Requirements.

i. Multiple beneficiaries are allowed. All beneficiaries must be individuals, estates, or certain types of charitable organizations. IRC § 1361(e)(1)(A)(i). No beneficiary may be a nonresident alien. Treas Regs § 1.1361-1(m)(1)(ii)(D).

1. A “beneficiary” of an ESBT for this purpose includes each person with a present, remainder, or reversionary interest in the trust. Treas Regs § 1.1361-1(m)(1)(ii)(A).

2. A permissible recipient under a power of appointment is considered a beneficiary only after that power of appointment is exercised in favor of such permissible recipient. Treas Regs § 1.1361-1(m)(1)(ii)(C).

3. Each “potential current beneficiary” of an ESBT

counts as a shareholder of the corporation. IRC § 1361(c)(2)(B)(v). A potential current beneficiary is a beneficiary that, during the time period at issue, may receive a trust distribution of income or principal. Treas Regs § 1.1361-1(m)(4)(i). If the trust has no potential current beneficiary for a period of time, then the trust is considered the shareholder for that period. IRC § 1361(c)(2)(B)(v).

ii. The trust did not purchase its interest in the corporation.

IRC § 1361(e)(1)(A)(ii). If any part of the trust’s basis in the stock is determined under IRC section 1012, then the trust acquired its interest by purchase. IRC § 1361(e)(1)(C). Thus, the ESBT must acquire its interest by gift or bequest. (Note that this requirement excludes ESBTs from part gift-part sale transactions discussed below.)



c. The trustee makes an ESBT election. IRC § 1361(e)(1)(A)(iii).

i. The Trustee files a statement with the IRS service center where the corporation files its income tax return to make the ESBT election. Treas Regs § 1.1361-1(m)(2)(i).

ii. Generally only one election is required, even if the ESBT

holds stock in multiple S corporations. However, if those corporations file returns in multiple IRS service centers, then an election must be filed in each applicable service center. Treas Regs § 1.1361-1(m)(2)(i).

iii. The ESBT election must be filed within the period required

for a QSST election, which is within two and a half months of when the subject trust receives the S corporation stock (or otherwise becomes an ineligible shareholder) or after the corporation elects S status. Treas Regs § § 1.1361-1(m)(2)(iii); 1.1361-1(j)(6)(iii). Revenue Procedure 2013-30 provides the method for obtaining relief from an inadvertent late election.

iv. A form of election meeting the requirements of Treasury

Regulations section 1.1361-1(m)(2) is included as Appendix 2.

d. The following trusts are not eligible to make ESBT elections. IRC

§ 1361(e)(1)(B).

i. A QSST. ii. A tax exempt trust.

iii. A charitable remainder annuity trust or a charitable remainder unitrust.

6. Voting Trusts. A voting trust is created primarily to exercise voting rights

of S corporation stock. All beneficial owners must be U.S. residents or citizens treated as owners of the stock under the grantor trust rules for each owner’s portion. Each beneficial owner of the voting trust is treated as a shareholder of the S corporation. IRC § 1361(c)(2)(B)(iv). An eligible voting trust is created by the shareholders under a written trust agreement that

a. Delegates to one or more trustees the right to vote;

b. Requires all distributions with respect to the S corporation stock

held by the trust to be paid to or on behalf of the beneficial owners of that stock;



c. Requires title and possession of that stock to be delivered to those beneficial owners upon termination of the trust; and

d. Terminates on or before a specific date. Treas Regs § 1.1361-

1(h)(1)(v).

iv. Certain charitable organizations. Qualified tax-exempt shareholders are defined in IRC § 1361(c)(6).

II. Estate Planning Techniques and Considerations with S Corporations a. Basic Estate Planning – Wills and Revocable Trusts

i. When drafting a will or revocable trust for a client who owns S corporation stock,

an attorney must be careful to ensure that all testamentary dispositions and continuing trusts will not inadvertently terminate the corporation’s S election. The will or revocable trust must require that the S stock be distributed or devised to an eligible shareholder. If this stock is to be distributed to a testamentary trust or continuing irrevocable trust, then that trust must be an eligible S corporation shareholder as outlined above.

ii. Revocable trust. As noted above, a revocable trust may hold S corporation stock for a period of two years after the death of the settlor. After that, stock must be distributed to an eligible S corporation shareholder or the trust must become a grantor trust, a QSST, or an ESBT.

iii. Wills. Using a will rather than a revocable trust as the primary estate planning

vehicle can have advantages for S corporation shareholders. As noted above, an estate is an eligible S corporation shareholder for a reasonable period necessary for estate administration. Revocable trusts must distribute or otherwise become qualified S corporation shareholders within two years. Often, a reasonable period to administer a complex, taxable estate exceeds two years. In addition, a testamentary trust is an eligible S corporation shareholder for two years following receipt of the S corporation stock without other qualification. Thus, that reasonable period of administration, which may exceed two years, has another two years beyond that (assuming use of the testamentary trust) before stock must be distributed to or retained by an otherwise eligible shareholder.

b. Common Estate Planning Techniques and How they Work With S Corporation Stock.

i. Irrevocable Trust Funded During Life (non-grantor trust). For an inter vivos

irrevocable trust that is not a grantor trust to be an eligible S corporation shareholder, it must qualify as a QSST or an ESBT and the appropriate election must be made.

ii. Irrevocable Trust Funded During Life (grantor trust). As noted above, grantor

trusts are eligible S corporation shareholders. Therefore, no further qualification or election is necessary for a grantor trust to hold S corporation stock. That



makes planning with irrevocable grantor trusts a popular technique with S corporation shareholder clients.

1. Crummey trusts. Many clients desire to make annual exclusion gifts to

family members but prefer to give to trusts for the benefit of those family members, rather than outright, due to the recipients’ age or financial capacity or for reasons of asset protection. Structuring such a trust as a grantor trust allows the donor to use this technique for S corporation stock without the limitations of a QSST or the often adverse tax aspects of an ESBT. Note: If the trust has hanging Crummey withdrawal powers, the beneficiary will be considered the grantor (and thus the S corporation shareholder) for the portion of trust principal subject to any unlapsed withdrawal right.

2. A popular estate planning technique with grantor irrevocable trusts is to

fund it via a part gift, part sale transaction. The settlor will give property to the trustee and then sell property (often substantially more than was contributed by gift) to the trustee. If structured properly and if using the appropriate assets, this technique can save substantial gift, estate, and generation-skipping transfer tax. Because of the pass through income taxation of an S corporation and because a grantor trust is a disregarded entity, using S corporation stock in such a part gift, part sale transaction works well.

3. Caution: For an estate planning technique involving the transfer of S

corporation stock to an irrevocable grantor trust to be successful, there must be some mechanism for the stock to be held by an eligible S corporation shareholder after the trust ceases to be a grantor trust (most commonly after the death of the grantor or after the grantor releases a power that caused the trust to be a grantor trust). Commonly, the trust will provide that the S corporation stock is distributed to individuals within two years of cessation of grantor trust status or that the trust become eligible for the beneficiary to make a QSST election within the time period. The trust will not be able to qualify as an ESBT if it purchased some or all of its S corporation stock.

4. Caution: A planner must be sure that the settlor has the ability to pay the

tax attributable to the S corporation stock in the grantor trust without access to trust assets and without a disproportionate distribution from the S corporation.

iii. Grantor Retained Annuity Trust (GRAT). If the grantor retains an annuity

interest with a reversion value worth more than five percent of the value of the trust estate, then the trust will be classified as a grantor trust. IRC § 673. To ensure that both the income and principal interests of the GRAT are classified as a grantor trust, planners should consider adding trust terms to ensure that it is a grantor trust for all purposes. If the GRAT is a grantor trust for all purposes, then the GRAT will be an eligible S corporation shareholder for as long as it remains a grantor trust.



iv. Charitable Remainder Trusts (CRT). CRTs are ineligible S corporation shareholders. Rev Rul 92-48, 1992-1 C.B. 301.

v. Common Types of Trusts That Might Want to Make QSST or ESBT Elections

1. General Power of Appointment Marital Deduction Trust (IRC

§ 2056(b)(5) trust). This trust will generally qualify to make a QSST election. See the requirements for a GPOA trust that qualifies for the marital deduction under IRC § 2056(b)(5).

2. Testamentary Qualified Terminable Interest Property Trust (IRC § 2056(b)(7) trust) (QTIP Trust). A QTIP trust will generally qualify to make a QSST election pursuant to the requirements of IRC § 2056(b)(7). Note: Two elections are required for a QTIP trust that holds S corporation stock: A QTIP election on the decedent’s estate tax return and a QSST election made by the surviving spouse/beneficiary.

3. Inter Vivos Qualified Terminable Interest Property Trust. Generally, an

inter vivos QTIP trust is a grantor trust under IRC § 677, so no QSST or ESBT election will be necessary for so long as it remains a grantor trust.

4. Qualified Domestic Trust (IRC § 2056A trust) (QDOT). A QDOT will

not be an eligible S corporation shareholder unless the surviving spouse becomes a US resident. As noted above, nonresident aliens are ineligible S corporation shareholders.

5. Section 2503(c) Trusts. A Section 2503(c) Trust for the benefit of a minor

will generally qualify for a QSST election if the trustee actually distributes all income.

6. Credit shelter trusts. A credit shelter trust will not qualify as a QSST if it

has multiple beneficiaries or if the trustee accumulates income. It might qualify as an ESBT if all other ESBT requirements listed above are satisfied.

c. Fiduciary Duties. In the context of closely-held businesses, and particularly family

businesses, individuals may find themselves with varying, and sometimes conflicting, duties. This is particularly true when S corporation shares are held in trust.

i. Minority Position. If the trustee holds a minority position in the company and thus lacks control, and if the majority shareholders take actions that constitute minority shareholder oppression, then the trustee may have a duty to take action to protect the beneficiaries’ and trust’s interest. See, i.e., trustee duties set forth in ORS 130.650-655. The action that the trustee’s fiduciary duty requires him or her to take may conflict with his or her personal interest or the interests of close family members.

ii. Majority Position. If the trustee holds a majority position and thus has control, he or she may have conflicting duties. Controlling shareholders can have fiduciary



duties to minority shareholders. See, i.e., Zidell v Zidell, Inc., 277 Or 413, 560 P2d 1086 (1977); Granewich v Harding, 329 Or 47, 985 P2d 788 (1999); Naito v Naito, 178 Or App 1, 35 P3d 1068 (2001). Trustees have fiduciary duties to beneficiaries. See, i.e., ORS 130.650-655. When those duties conflict, the trustee may be in an untenable position for which he or she may need to petition the court for instructions on how to resolve. See below for actions that may mitigate risk from conflicting duties.

iii. Conflicting Duties and Loyalties. Many times, particularly in family business

contexts, individuals wear more than one hat. Regardless of whether the trustee holds a majority or a minority position, he or she may personally be a shareholder. An individual may be a shareholder of a family S corporation both in his or her individual capacity and as trustee of a trust for the benefit of other family members. That individual may face circumstances where his or her fiduciary duty to the trust beneficiaries conflicts with his or her personal interest, with outside business interests of the trust beneficiaries, or with the interests of other family members. Sometimes, conflicts such as these are unavoidable in the closely-held business and family business context, but trustees and shareholders can mitigate the risks of such conflicts. Such mitigation techniques may include: strict adherence to corporate formalities; strict adherence to corporate best practices; obtaining legal advice; setting reasonable expectations; good communication; obtaining prior approval from beneficiaries for trustee actions; full disclosure of potential conflicts (both in general and relating to specific transactions or actions); and employing independent decision-makers. When drafting trust agreements under circumstances where these potential issues may be present, the drafting attorney may help to mitigate these issues by techniques such as building in a beneficiary’s veto or advisory rights to certain trustee actions or allowing for the appointment of an independent trustee for certain trustee actions that might have an inherent conflict.

d. Treatment of Intangible Assets of S Corporation During Estate Administration

i. In Estate of Adell v. Comm. T.C. Memo. 2014-155, the decedent’s estate included all of the equity of a C Corporation. In determining the value, the court allowed an operating expense adjustment of approximately 40%, in the valuation formula, to account for the son’s personal goodwill.

1. The original 706 included a value of $9.3MM for the business, which was followed by an unrelated amendment and then a second amendment to reflect a zero value of the business.

2. In 2010, the son formed NEWCO, resigned from the former company along with all but one employee, and secured the single customer of the former company.

3. In Court, the estate’s experts argued for a $4.3 value to reflect the valuation of the Company’s assets, while the IRS expert was pursuing a $26MM value, with Court concluding on the original $9.3MM.



ii. Valuation of interests in businesses include assets of the business. Reg. §20.2031-3.

1. Ownership of intangible assets in the form of rights to relationships cannot be attributed to the company when there was no employment agreement, covenant not to compete, or any other agreement that would give the company ownership. Martin Ice Cream Company v. Comm. 110 T.C. 189 (1998).

2. Intellectual property such as business name may be intentionally or unintentionally outside of the S Corporation, registered in the founder’s name or in another entity.

III. Income Tax Considerations for Trust and Estate Administration with S Corporations

a. Selecting a QSST vs. an ESBT

i. Flexibility in terms

1. ESBTs are more flexible with regard to permissible beneficiaries. Unlike

a QSST that must have a single current income beneficiary, an ESBT may have multiple beneficiaries, including estates, other trusts, and charities.

2. ESBTs are also more flexible with regard to income distributions. A QSST must distribute all income annually to the single current income beneficiary. An ESBT may be a sprinkle trust and may permit the accumulation of income.

3. To qualify a QSST, the beneficiary must make the election. To qualify an

ESBT, the trustee must make the election. If a beneficiary is unwilling to make the QSST election, then the trustee’s ESBT election may be the only option for the trust to qualify as an S corporation shareholder.

ii. Income taxation

1. For a QSST, the single current income beneficiary is treated as owning the

QSST’s S corporation stock for income tax purposes. Therefore, all gain or loss is reported on that beneficiary’s personal income tax return. Tax is calculated and paid at that beneficiary’s income tax rate.

2. For an ESBT, income taxation is governed by Internal Revenue Code

section 641 and the regulations thereunder. For income taxation, an ESBT may have up to three separate shares:

a. For any part of an ESBT that is also a grantor trust, the person

considered to be the owner of that part for income tax purposes will report the gain or loss from that share on his or her personal income tax return. Treas Regs § 1.641(c)-1(b)(1), (c).



b. For any part of an ESBT that is not a grantor trust but holds no S corporation stock, then that part of the trust is taxed under the income tax rules for trusts that are neither grantor trusts nor ESBTs. Treas Regs § 1.641(c)-1(g)(1).

c. Any part of an ESBT that holds S corporation stock and is not

considered a grantor trust is treated as a separate trust. Treas Regs § 1.641(c)-1(a) (b)(2). The income of such separate trust, other than capital gains, is taxed at the highest marginal rate for trusts. IRC § 641(c)(2)(A). See IRC §1(e), (h). The exemption for such separate trust under IRC § 55(d) for alternative minimum tax is zero. IRC § 641(c)(2)(B). Regardless of what distributions the ESBT makes, no income may be apportioned to any beneficiary and no distributions carry out distributable net income. IRC § 641(c)(2), (3).

3. Analysis.

a. Generally. Because all ESBT income is taxed to the trust at the highest rate and all QSST income is taxed to the beneficiary at his or her rate, then income tax considerations often indicate choosing QSST status over ESBT. However, if the beneficiary is in the highest tax bracket, then the question or whether to qualify a trust as a QSST or an ESBT can be income tax neutral.

b. With the 3.8% net investment tax, however, a QSST may be preferable, regardless of the beneficiary’s income tax bracket. If the beneficiary materially participates in the business, the net investment tax may not apply because the beneficiary is considered the owner of the S corporation stock for income tax purposes.

c. If the beneficiary is in the highest federal income tax bracket and

resides in a high-income tax state and the trust is sited in a low- or no-income tax state, then making an ESBT election might actually be better than a QSST election because income would be taxed to the trust without being taxed to the beneficiary in the high-income tax state.

b. Section 645 Election. Under IRC section 645, following the death of a decedent, the

successor trustee of the decedent’s revocable trust and the executor of the decedent’s estate may elect to treat the trust as part of the estate for income tax purposes. As noted above, a revocable trust must distribute S corporation stock or otherwise become an eligible S corporation shareholder within two years of the decedent’s date of death. An estate, however, may continue as an eligible S corporation shareholder for a reasonable period of administration, which may exceed two years. Therefore, a section 645 election may extend the period during which the revocable trust may be administered without the necessity of distribution of S corporation stock or a QSST or ESBT election.



c. Allocating income in the year of death.

i. When a shareholder terminates his or her interest in an S Corporation (dies), annual corporate income items are prorated between the decedent and the successor shareholder by allocating an equal daily amount to the period before and after death. IRC §1377(a)(1); Reg. §1.1377-1(a).

ii. Income allocated to the period before death is included on the decedent’s final income tax return. IRC §1377(a)(1); Reg. §1.1377-1(a).

iii. Income allocated to the period after death is included on the successor’s income

tax return. IRC §1377(a)(1); Reg. §1.1377-1(a).

iv. Alternatively, the S corporation shareholders may elect the closing of the books method, through an election to terminate the year. This election divides the corporation’s taxable year into two separate years, the first of which ends at the close of the day the shareholder died. IRC §1377(a)(2); Reg. §1.1377-1(b)(1). This election is available only if a shareholder terminates his entire interest in the S corporation, all of the “affected shareholders” agree, and the corporation properly attaches the election to its tax return for the year. Reg. §1.1377-1(b)(5). Affected shareholders include those shareholders whose interest is terminated and those to whom shares are transferred during the year. Reg. §1.1377-1(b)(2).

1. An election to terminate the year does not affect the due date of the

corporate return and may be filed up until the final due date of an amended return (typically 3-years after the original extended due date). Reg. §1.1377-1(b)(5).

2. A shareholder’s interest in an S corporation is terminated when the

shareholder’s entire stock ownership ceases, whether through a gift, spousal transfer, or death of a shareholder. Reg. §1.1377-1(b)(2).

v. Example: 100% shareholder passed away on June 30. The S corporation had $1

million in ordinary income during the 6-months from July 1 to December 31 and no other income or expenses during the year. Under a regular daily proration, decedent’s final income tax return and decedent’s beneficiary would each report $500,000 of ordinary income. With an election to terminate year, the entire $1 million would be reported by the beneficiary. Reg. §1.1361-1(j)(7).

vi. Consequences:

1. Beneficiary and decedent tax rates may be different, including NII 3.8% tax,

2. Allocation to the beneficiary may provide deferral if using a fiscal year estate,

3. For a taxable estate, allocation to the decedent may reduce the taxable

estate through increased income tax liability,



4. Different individuals may have income tax liability, depending on the terms of estate documents,

5. Allocation of income to the decedent may result in loss of basis as

determined by IRC § 1014.

d. Family Groups. S corporations report gain on the distribution of appreciated property to shareholders. Shareholders’ stock redemptions are also treated as exchanges. IRC §311(b) and IRC §302(b). Therefore, the tax costs of liquidating an existing S corporation followed by a contribution of the business to a more flexible entity such as a LLC may be prohibitive.

i. As a wealth transfer vehicle, as mentioned earlier, a major downside of a S

corporation is that there is no provision to adjust the basis of the assets inside the S corporation as there is with IRC §754 for partnerships with a deceased partner.

1. This may not be an issue where the founder’s plan is to transfer all or a majority through gifting.

2. Liquidation and reforming as an LLC after death of founder may, as discussed earlier, may have high income tax costs to other family S corporation owners.

ii. Family members are to receive reasonable compensation for their services and

contribution of capital. Reg. 1.1366-3. Additionally, differences in voting rights are permitted. Reg. 1.1361-1.

IV. S Corporation Dispositions

a. Asset Sales (Timing of asset sales with liquidation)

i. The stock of an S corporation acquires a basis equal to its market value under IRC

§1014, along with a long-term holding period under IRC §1223(11).

ii. There is no provision to adjust the basis of the assets inside the S corporation as there is with IRC §754 for partnerships with a deceased partner. Therefore, the income tax consequences of an S corporation selling property are unchanged by a death of a shareholder. The basis of a shareholder’s share of stock is increased by the shareholder’s portion of income items. Reg. §1.1367-1(b)(2).

1. Unless the corporation has other losses to offset gains on sales of assets, it

is generally desirable to plan to liquidate the corporation in the same tax year as the asset sale to utilize the liquidation loss in the same tax year as the gain.

2. Liquidation losses may not offset gains for assets held by the corporation outside of the shareholder’s resident state.



3. Certain S corporation gain items may be subject to higher income tax rates, such as ordinary income property and IRC §1250 unrecaptured gain.

iii. Example. Shareholder was a 100% owner in an S corporation, where the

corporation’s only asset was land valued at $100,000 with an original cost basis of $20,000. The S Corporation’s IRC §1014 value was also $100,000 (assuming no discounts). Land sale and liquidation in same year: S Corporation reports $80,000 capital gain, S Corporation stock basis is increased by gain to $180,000 Proceeds of $100,000 are distributed for a $80,000 loss on liquidation Gain and loss of $80,000 are offsetting.

iv. When there is a distribution of appreciated property from an S corporation to a shareholder, the distribution is treated as a deemed sale of the asset by the S corporation to an unrelated party at market value, where the income from the sale is passed to the S corporation shareholders. IRC §301(b); §1368(a).

1. If planned with liquidation as described above, the additional income tax may be limited to the items that are taxed at rates higher than capital gains rates.

2. Additional tax may also result from valuation discount on the entity, where the stock basis is lower value than the S corporation’s underlying assets.

3. There may be a planning opportunity for additional depreciation from stepped up basis for property that is to be retained.

v. S corporation stock basis determined under IRC §1014 is reduced by the portion

of the value of the stock which is attributable to items constituting IRD. IRC §1367(b)(4)(B). Additionally, IRC §691 shall be applied with respect to any item of income of the S Corporation in the same manner as if the decedent had held the item directly.

1. IRD items that may come up in an S corporation may include cash basis receivables and installment obligations. IRC §691(a)(2) and IRC §691(a)(4).

2. IRC §1367(b)(4)(B) provides that reduction from §1014 value shall be the portion of the value of the stock attributable to item of IRD. This is not the same as the value of the item constituting IRD inside the corporation.

3. A specific bequest of property including IRD would include S corporation

stock with IRD. IRC §691(a)(2).



b. Stock Purchases Treated as Asset Acquisitions – IRC § 338(h)(10)

i. When a purchaser acquires S corporation stock, there is generally no adjustment

to the inside basis in the S corporation’s assets, unless there is a joint election made under IRC§338(h)(10).

ii. The mechanics of an IRC §338(h)(10) election are:

1. An IRC 338(h)(10) election is made jointly by purchaser and selling S corporation shareholders, within the 15th day of the ninth month after the transactions occurs, where all S corporation shareholders must consent. Reg. 1.338(h)(10)(c)(3).

a. The purchaser must be a C corporation, although a partnership or individual(s) could fund an acquisition corporation to complete the transaction. Reg. 1.338-1(a).

b. A purchase of 80 to 100% of the S Corporation required. IRC §338(d)(3).

c. Negotiated as part of purchase transaction.

2. The selling S corporation is deemed to have sold assets to an unrelated party in an amount equal to the stock purchase price plus the liabilities discharged. Reg. §1.338-1(a).

3. The selling S corporation is deemed to liquidate and recognizes gain or loss on liquidation and the S corporation and shareholders recognize no gain or loss on the stock sale. Reg. §338(h)(10)-1(d)(5)(iii); Reg. §338(a).

4. The buyer is deemed to have purchased the assets, receiving an inside stepped up basis. IRC §338(b).

iii. The benefits of a IRC§338(h)(10) to the buyer are a stock transaction along with stepped up basis in assets. IRC §338(b).

iv. The seller may have additional tax if there are assets that are taxed at higher rates such as ordinary income property.

c. S Corporation Stock Sales. Without an IRC §338(h)(10) election, the basis of the assets

inside the S Corporation remain unchanged. Therefore, a regular S Corporation stock purchase is sometimes or frequently prohibitive from a cash flow standpoint to the buyer.





Appendix 1 – QSST Election Form

Name of Beneficiary Beneficiary Address

Beneficiary Phone Date IRS Service Center Address where Corporation files return RE: Qualified Subchapter S Trust Election Name of Trust Name of Corporation Dear Sir or Madam: This letter is an election to treat a trust as a Qualified Subchapter S Trust (QSST) under Internal Revenue Code section 1361(d)(2) effective on effective date. Current income beneficiary: Beneficiary’s name Beneficiary’s address Beneficiary’s social security number

Trust: Trust’s name (and trustee) Trust’s address Trust’s taxpayer identification number

Corporation: Corporation’s name Corporation’s address Corporation’s taxpayer identification number The date on which the name of corporation stock was transferred to the name of trust was date of transfer. Under the terms of the name of trust and applicable law in state of governing law, I am the sole income beneficiary during my lifetime. I am a United States resident or citizen. [Note: If spouses are beneficiaries, state that they will file joint income tax returns and that they are both US residents or citizens.] Trust corpus cannot be distributed to anyone other than me during my lifetime. My income interest will terminate upon my death. [Note: If the trust terminates upon other occurrence, specify that occurrence.] If the trust terminates during my lifetime, then all trust corpus will be distributed to me. The terms of the trust require it to distribute all income to me. [Note: If the trust terms do not require that, then state that the trustee will in fact distribute all income to the beneficiary.] The trustee may not distribute income or principal in satisfaction of the grantor’s legal obligation of support. Sincerely, Income Beneficiary’s Name and Signature





Appendix 2 – ESBT Election Form Name of Trustee Trustee Address

Trustee Phone Date IRS Service Center Address where Corporation files return RE: Electing Small Business Trust Election Name of Trust Name of Corporation(s) Dear Sir or Madam: This letter is an election to treat a trust as an Electing Small Business Trust (ESBT) under Internal Revenue Code section 1361(e)(3) effective on effective date. Potential current beneficiary: (list all that apply) Beneficiary’s name Beneficiary’s address Beneficiary’s social security number

Trust: Trust’s name (and trustee) Trust’s address Trust’s taxpayer identification number

Corporation: (list all that apply) Corporation’s name Corporation’s address Corporation’s taxpayer identification number The date on which the name of corporation stock was transferred to the name of trust was date of transfer. [List multiple if appropriate.] The trust meets all of the definitional requirements of Internal Revenue Code section 1361(e)(1). Specifically, all trust beneficiaries are individuals, estates or qualified charitable organizations. [Note: elaborate under IRC § 1361(e)(1)(A)(i)(III) if applicable.] The trust did not acquire its interest in an S corporation stock by purchase. The trust is not a Qualified Subchapter S Trust, a tax-exempt trust, a charitable remainder annuity trust, or a charitable remainder unitrust. All potential current beneficiaries of the trust meet the shareholder requirements of Internal Revenue Code section 1361(b)(1). Specifically, no potential current beneficiary is a nonresident alien. [If the ESBT has a beneficiary that is an estate or a trust, specify why that estate or trust is an eligible S corporation shareholder.] Sincerely, Name and signature of trustee



Chapter 3

The Past, Present, and Future of the IRS Federal Estate Tax Program

riChard eiChen

Attorney at LawPortland, Oregon

Contents

Presentation Slides . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–1

Major Enacted Tax Legislation Relating to Estate Planning . . . . . . . . . . . . . . . . . . . . . . . . 3–9

IRS Statistics of Income—Estate Tax Returns Filed for Wealthy Decedents, 2003–2012 . . . . . . . 3–15

Federal Taxation of Inheritance and Wealth Transfers . . . . . . . . . . . . . . . . . . . . . . . . . . 3–17

History, Present Law, and Analysis of the Federal Wealth Transfer System . . . . . . . . . . . . . . 3–39

Table of Contents from “A Fiduciary Income Tax Primer” . . . . . . . . . . . . . . . . . . . . . . . 3–93

Chapter 3—The Past, Present, and Future of the IRS Federal Estate Tax Program




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Richard Eichen, Esq. – Portland, OR

The Past

◦ The People

◦ The Tax Law

◦ The Process



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2

The Present

◦ What has changed?

◦ What remains constant?

The Future

◦ Examination Redux

◦ Technology

◦ Electronic Filing

◦ What do you want to see from the IRS?



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Non unified Estate & Gift Tax Rates Marital Deduction ½ Adjusted Gross Estate Community Property Equity Contemplation of Death (Sec. 2035) Rules Specific Exemption Estate (60 G) & Gift (30 G) Joint Property Inclusion by Contribution Payment by “Flower Bonds”

Unified Estate & Gift Tax Rates Generation Skipping Transfer Tax Marital Deduction Increase 2032A / 6166 Business & Farm Rules Automatic Inclusion for Transfers within three Years



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Unlimited & QTIP Marital Deduction

Qualified Joint Interests

Sec. 2039 Pension Annuities 100% Inc.

ATG’s, no Three Year GE Inclusion

Deficit Reduction Act of 1984 ◦ AFR Rules

Tax Reform Act of 1986◦ GSTT◦ Depreciation



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Revenue Act of 1987◦ Chapter 14 Estate Freeze◦ ESOP Deduction◦ Rates & Exemption Changes

Omnibus Act of 1989◦ Accuracy Related Penalties

Qualified Family Business Deduction (QFOBI)

Inflation Indexing

Credit Rate Increase Phase-In



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Giving FET the Byrd

Base Increase / Rate Decrease

SITC Repeal

◦ 2010 Unification Portability / DSUE

◦ 2012 Permanence Marginal Rate 40% SIT Deductibility Exemption Equivalent Indexed from 2011



6/12/2015

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Significant Tax Law Changes (3-11)

Filing Requirements & Tax Rates (2) (3-29/54)

FET Returns as %age of Adult Deaths (3-35)

CHC Stock Included in FET Filings (3-88)

Liquidity Ratios (2) (3-85 / 86)

See page 3–85



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See page 3–86

Transfers Valuation Issues GRAT’s Gift’s of Notes – Sales Non Pro-rata Distributions Fiduciary Income Taxes



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The Estate Tax: Ninety Years & Counting, Jacobsen, Raub & Johnson;

History, Present Law, And Analysis of the Federal Wealth Transfer Tax System, JCT;

Federal Taxation of Inheritance and Wealth Transfers, Johnson & Eller;

Estate Tax Changes Past, Present and Future, Aucutt;

Estate Planning Update, Akers;

TaxGirl, Kelly Phillips Erb;

Tax Policy Center, Major Enacted Tax Legislation – All Years;

A Fiduciary Income Tax Primer, Jones.

Revenue Effects of Major Tax Bills, Tempalski.





Major Enacted Tax Legislation Relating to Estate Planning1

Since 2000

American Taxpayer Relief Act of 2012

• Permanently extended certain 2001 tax cuts.

. . . .

• Extended $5 million estate and gift tax exemption and top estate tax rate of 40 percent.

• Permanently extended certain 2003 tax cuts.

. . . .

• Extended certain 2009 tax cuts through 2017.

. . . .

• Provided permanent Alternative Minimum Tax (AMT) relief.

. . . .

• Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010

. . . .

• Estate tax. Allowed estate tax to return with exemption amount of $5 million and 35 percent maximum rate for 2011 and 2012.

. . . .

Pension Protection Act of 2006

. . . .

• Charitable contributions and tax exempt organizations. Allowed tax-free distributions from IRAs to certain public charities from age 70 ½ and older, not to exceed $100,000 per taxpayer; extended current law charitable deductions for food and book inventories; adjusted basis of S corporation stock for certain charitable contributions; encouraged contributions of property interest made for conservation purposes; restricted qualifying contributions of clothing and other household items to those in good condition, required greater substantiation (e.g., receipts for all cash gifts) for gifts made, and penalized contributors and appraisers who grossly overvalue donated property.

. . . .

1 Excerpted from Major Enacted Tax Legislation—All Years, http://www.taxpolicycenter.org/legislation/allyears.cfm.



American Jobs Creation Act of 2004 (AJCA)

. . . .

• Revenue provisions. Extended certain custom user fees; reformed the tax treatment of leasing transactions; modified the dispositions of transmission property to implement FERC restructuring policy; installed provisions to reduce tax avoidance and curtail tax shelters; modified charitable contribution rules for donations of patents and other intellectual property; modified the valuation of the charitable deduction for vehicles; and provided consistent amortization periods for intangibles, among many other items.

. . . .

Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA)

. . . .

• Estate and gift tax reduction and elimination. Gradually reduced the estate and gift tax rate from 55 percent to 45 percent by 2007; raised the effective exemption from $1 million in 2002 to $3.5 million in 2009. Eliminated the estate tax portion entirely in 2010 in lieu of a capital gains tax with high disregard ($3.3 million) for transfers to a surviving spouse.

. . . .

1990-1999

Internal Revenue Service Restructuring Act of 1998

• Mission statement revision. Directed IRS to revise its mission statement to provide greater emphasis on serving the public; replaced three-tier geographic organization with a structure that features operating units geared around different types of taxpayers and their specialized needs; created an independent appeals function within the IRS.

• IRS Oversight Board. Created board to oversee the administration, management, and conduct of the IRS, ensuring that the organization and operations of the IRS allow it to properly carry out its mission.

• Appointment and duties of IRS Commissioner and other appointed personnel. Gave Oversight Board authority to recommend candidates, who should have a strong management background, to the President, for appointment to a statutory five-year term (instead of a non-specific term), with the advice and consent of the Senate. President can still select and remove candidates.

• Taxpayer advocate role revision. Taxpayer Advocate now to be appointed by Secretary of the Treasury; limited the Advocate's former and future involvement with the IRS, and provided clearer definitions and limits on the scope of taxpayer assistance orders that the Advocate can issue.

. . . .



Taxpayer Relief Act of 1997

. . . .

• Estate and gift tax reductions. Boosted the present law unified credit beginning in 1998 from $600,000 per person to $1 million by 2006. Also indexed other estate and gift tax parameters, such as the $10,000 annual gift exclusion, to inflation after 1998.

. . . .

• Excise taxes. Phased-in 30 cents per pack increase in the cigarette tax. Extended air transportation excise taxes.

Taxpayer Bill of Rights 2 of 1996

• Taxpayer Advocate. Established position of Taxpayer Advocate within the IRS, replacing Taxpayer Ombudsman. The Advocate is appointed by the Commissioner. The Advocate has four responsibilities: (1) assist taxpayers in resolving problems with the IRS, (2) identify problem areas where taxpayers have difficulty dealing with the IRS, (3) propose administrative changes within IRS that might mitigate these problem areas, and (4) identify potential legislative changes that might mitigate these problem areas.

• Installment agreement modification. Where the IRS enters into a paid installment agreement with taxpayers to facilitate the collection of taxes, it must notify said taxpayers within 30 days if such agreement is modified or terminated for any reason other than the collection of the tax is determined to be in jeopardy. Additionally, the IRS must establish procedures for independent administrative review of installment agreements that are modified or terminated.

• Interest and penalties abatement. IRS is directed to abate interest penalties against the taxpayer caused by any unreasonable error or delay on the part of IRS management.

• Other provisions. Re-examination of joint and several liability for spouses filing joint returns; flexibility in moderating collection activities according to level of compliance, and a number of other provisions that boost taxpayers' standing relative to the IRS in legal disputes.

Omnibus Budget Reconciliation Act of 1990

. . . .

• Income tax base erosion. . . . Modified estate freeze rules. Eliminated appreciation of certain donated property as a minimum tax preference item.

• Miscellaneous revenue-raisers. . . . [R]e-imposed Leaking Underground Storage Tank Trust Fund tax; . . . improved IRS ability to obtain information from foreign corporations; . . . reduced business income tax loopholes.

1980-1989


• Limited tax deductions and exclusions for employee stock ownership plans.



. . . .

Technical and Miscellaneous Revenue Act of 1988

• Passed technical corrections for the Tax Reform Act of 1986.

. . . .

The Family Security Act of 1988

. . . .

• Required taxpayer identification number for younger children.

Continuing Resolution for Fiscal Year 1988

• Increased IRS funding for more enforcement staff and equipment.

. . . .


. . . .

• Extended telephone excise tax, FUTA tax, 55 percent estate tax rate, and employer Social Security to cover cash tips.

• Increased IRS and BATF fees.

• Continuing Resolution for Fiscal Year 1987

• Increased Internal Revenue Service funding for staffing and equipment.

. . . .

Tax Reform Act of 1986

. . . .

• Repealed two-earner deduction, long-term capital gains exclusion, state and local sales tax deduction, income averaging, and exclusion of unemployment benefits. Limited IRA eligibility, consumer interest deduction, deductibility of passive losses, medical expenses deductions, deduction for business meals and entertainment, pension contributions, and miscellaneous expense deduction.

. . . .

Deficit Reduction Act of 1984

. . . .

• Placed time value of money restrictions on accounting rules.

. . . .



• Set maximum estate tax rate at 55 percent.

. . . .

Economic Recovery Tax Act of 1981

. . . .

• Estate and gift tax provisions. Permitted unlimited marital deduction: increased estate credit to exempt from tax all estates of $600,000 or less; and reduced maximum estate tax rate from 70 to 50 percent.

. . . .

1970-1979

. . . .

Tax Reform Act of 1976

. . . .

• Estate and Gift Tax. Created unified rate schedule for estate and gift taxes with $175,000 exemption.

. . . .





Estate Tax Returns Filed for Wealthy Decedents, 2003–2012

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The Federal estate tax is a tax on the transfer property at death. It is applied to estates for which at-death gross

Estate tax returns are due 9 months from the date of

Charitable bequests and marital transfers can be taken as deductions when calculating estate tax liability.

Highlights of the Data The number of estate tax returns declined 87 percent

from about 73,100 in 2003 to about 9,400 in 2012

threshold.

In 2012, the total net estate tax reported on all estate

California had the highest number of estate tax

Texas, and Illinois.

percentage of the adult population (ages 18 and over),

Stock and real estate made up about half of all estate tax decedents’ asset holdings in 2012.

-lion or more held a greater share of their portfolio in stocks (about 40 percent) and lesser shares in real estate and retirement assets than decedents in other total asset categories.

Further information about tax statistics is available on the IRS’ website at www.irs.gov/taxstats -mation on the estate tax, including articles and detailed statistical tables are located at http://www.irs.gov/uac/SOI-Tax-Stats-Estate-Tax-Statistics.

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Billionsof dollars

Net Estate Tax

Numberof returns

Estate Tax Returns Filed and Total NetEstate Tax, 2003–2012

0

10

20

30

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Returns Filed

0 10 20 30 40 50

Stock

Percent of total assets

Real estateBonds

CashSmall businesses

Retirement assetsOther assets

Under $5M

StockReal estate

BondsCash

Small businessesRetirement assets

Other assets

$5M under $10M

StockReal estate

BondsCash


Other assets

$10M under $20M

Percent of total assets

StockReal estate

BondsCash


Other assets0 10 20 30 40 50

$20M or more

Portfolio Composition of Estates, by Sizeof Total Assets, 2012

Estate Tax Filing Thresholds, 2003–2012Year of death tate ta thre ho d

20032004

2006200720082009201020112012

2010. The law, which was retroactive for all 2010 decedents, raised the estate tax exemption

Allocation of Increase in Basis for Property Acquired From a Decedent.Source: IRS, Statistics of Income, August 2013





- 3 -

FederalTaxation of Inheritance and Wealth Transfers

Barry W. Johnson and Martha Britton Eller, Internal Revenue Service

Introduction: Inheritance and Taxation

For most of the 20th century and at key pointsthroughout American history, the Federal governmenthas relied on estate and inheritance taxes as sources offunding. The modern transfer tax system, introduced in1916, provides revenue to the Federal governmentthrough taxes on transfers of property between livingindividuals--inter vivos transfers--as well as through atax on transfers of property at death. Proponents oftransfer taxation embrace it both as a “fair” source ofrevenue and as an effective tool for preventing the con-centration of wealth in the hands of a few powerful fami-lies. Opponents claim that transfer taxation creates adisincentive to accumulate capital and, thus, is detrimen-tal to the growth of national productivity. Controversyover the role of inheritance in democratic society andthe propriety of taxing property at death is not new, butis rooted firmly in arguments that have raged sinceWestern society emerged from its feudal foundations.Central to both historic and current debate is the diver-gent characterization of inheritance as either a “right”or a “privilege.” An understanding of these arguments,and of the history surrounding the development of themodern American transfer tax system, provides a foun-dation for evaluating current debates and proposals forchanges to that system.

Historical Overview

Taxation of property transfers at death can be tracedback to ancient Egypt as early as 700 B.C. (Paul, 1954).Nearly 2,000 years ago, Roman Emperor CaesarAugustus imposed the Vicesina Hereditatium, a tax onsuccessions and legacies to all but close relatives (Smith,1913). Taxes imposed at the death of a family memberwere quite common in feudal Europe, often amountingto a family’s annual property rent. By the 18th century,stamp duties and registration fees on wills, inventories,and other documents related to property transfers at deathhad been adopted by many nations.

Inheritance in Early America: English Foundations

American ideas concerning the rights of individu-als in the new republic can be traced to the writings ofEnglish philosopher John Locke. Writing in the last halfof the 17th century, he suggested that each citizen wasborn with certain natural, or God-given, rights; chiefamong those rights was property ownership. Citizenshad a right to own as much property as they could em-ploy their labor upon, but not to own excessive amountsat the expense of the rest of society. Further, he arguedthat the right to bequeath accumulated property to chil-dren was divinely ensured. “Nature appoints the de-scent of their [parent’s] property to their children whothen come to have a title and natural right of inheritanceto their father’s goods, which the rest of mankind can-not pretend to” (Locke, 1988:207). Likewise, Lockefelt that a father should inherit a child’s property if thechild died without issue. If, however, a person diedwithout any kindred, the property should be returned tosociety. Government was established at the will of thepeople and was charged with protecting these rights, ac-cording to Locke. However, government had an evenhigher responsibility--to ensure the benefit of all soci-ety. When societal and individual rights clashed, sug-gested Locke, it was the civil government’s duty to ex-ercise its prerogative in order to ensure the commongood.

The idea that inheritance was a “natural right” wasrefuted nearly a century later by English jurist WilliamBlackstone. In his 1769 Commentaries on the Law ofEngland, Blackstone wrote that possession of propertyended with the death of its owner and, thus, there wasno natural right to bequeath property to successive gen-erations. Therefore, any right to control the dispositionof property after death was granted by civil law--not bynatural law--primarily to prevent undue economic dis-turbances. Thus, Blackstone concluded that the gov-ernment had the right to regulate transfers of propertyfrom the dead to the living. His interpretation of law

Downloaded from http://www.irs.gov/pub/irs-soi/inhwlttr.pdf.



- 4 -

JOHNSON AND ELLER

“has served as the legal foundations upon which deathtaxes in Anglo-American tax systems rest” (Fiekowsky,1959:22).

The belief that government was responsible for theprotection of the general good, espoused by John Lockeand others, laid the foundation for the Utilitarian move-ment in English social philosophy. Jeremy Bentham,one of the greatest proponents of Utilitarian philosophy,rejected the idea of natural rights. Instead, he stressedthe higher goal of ensuring the general welfare. He andhis followers believed in a government that played anactive role in moving society toward that goal. Bentham,therefore, advocated strong regulation of inheritances“in order to prevent too great an accumulation of wealthin the hands of an individual” (Chester, 1982:18).

Yet, the idea of government actively engaged in pro-moting the general welfare was rejected by economistAdam Smith, a contemporary of both Blackstone andBentham and the father of classical economics. Smithbelieved that an unregulated economy, driven by thenatural interplay of selfish individual desires, would pro-duce the greatest good for society. While he seemed toaccept the government’s right to tax inheritances, he ar-gued against it. He called all taxes on property at death“more or less unthrifty taxes, that increase the revenueof the sovereign, which seldom maintains any but un-productive labor, at the expense of the capital of thepeople, which maintains none but productive” (Smith,1913:684). Later, economist David Ricardo, writing inthe early 19th century, reinforced the idea. He suggestedthat English probate taxes, legacy duties, and transfertaxes “prevent the national capital from being distrib-uted in the way most beneficial to the community”(Ricardo, 1819:192).

These, then, are the somewhat divergent philoso-phies from which Thomas Jefferson, in drafting the Dec-laration of Independence, developed his idea of God-given, or natural, rights that emphasize personal and po-litical freedoms. Jefferson argued that the use of prop-erty was a natural right, but that the right was limited bythe needs of the rest of society. Furthermore, he alsoargued that property ownership ended at death. Whilehe did not call for abolishing the institution of inherit-ance, he did advocate a strong role for government in its

regulation. As in other areas of American life, Jeffersonheavily influenced later thinking about property rights,inheritance, and taxation by governmental bodies.

The Stamp Tax of 1797

In general, early American government adopted alaissez-faire approach to the economy, an approach ad-vocated by Adam Smith. However, when Congressneeded to raise additional funds in response to the un-declared naval war with France in 1794, it chose a deathtax as the source of revenue. The Stamp Act of 1797was enacted to finance the naval buildup necessary forthe national defense. Federal stamps were required onwills offered for probate, as well as on inventories andletters of administration. Stamps were also required onreceipts and discharges from legacies and intestate dis-tributions of property (Zaritsky and Ripy, 1984). Du-ties were levied as follows: 10 cents on inventories andthe effects of deceased persons, and 50 cents on the pro-bate of wills and letters of administration. The stamptax on the receipt of legacies was levied on bequestslarger than $50, from which widows (but not widow-ers), children, and grandchildren were exempt. Bequestsbetween $50 and $100 were taxed 25 cents; those be-tween $100 and $500 were taxed 50 cents; and, an ad-ditional $1 was added for each subsequent $500 bequest.In 1802, the crisis ended, and the tax was repealed (Re-peal of Internal Tax Act, 1802). In 1815, Treasury Sec-retary Alexander Dallas proposed the resurrection of thetax to provide revenue for the war with England. TheTreaty of Ghent, however, ended the war while the taxwas still under consideration, and the tax was subse-quently dropped (Zaritsky and Ripy, 1984).

In the years immediately preceding the war betweenthe States, revenue from tariffs and the sale of publiclands provided the bulk of the Federal budget. Inherit-ance taxes, however, were a source of revenue for manyStates. Early in the 19th century, Supreme Court Jus-tices John Marshall and Joseph Story defended anindividual’s natural right to own property. However,their belief that inheritance was a civil, not a naturalright affirmed the States’ right to regulate inheritances(Chester, 1982). Later, U.S. Supreme Court JusticeRoger Taney, a Jackson appointee, described the inher-itance tax in the case of Mager v. Grima (1850). “If a



- 5 -

FEDERAL TAXATION OF INHERITANCE AND WEALTH TRANSFERS

State may deny the privilege [of inheritance] altogether,”he wrote, it may, when it grants that privilege, “annex tothe grant any conditions, which it supposes to be re-quired by its interests or policy” (49 U.S.:494).

The Tax Act of 1862

The advent of the Civil War again forced the Fed-eral government to seek additional sources of revenue,and a Federal inheritance tax was enacted in the TaxAct of 1862. However, the 1862 tax differed from itspredecessor, the stamp tax of 1797. In addition to adocument tax on the probate of wills and letters of ad-ministration, the 1862 tax package included a tax on theprivilege of inheritance. Originally, the tax only appliedto the devise of personal property, and tax rates weregraduated based on the legatee’s relationship to the de-cedent, not on the value of the bequest or size of theestate. Rates ranged from 0.75 percent of bequests toancestors, lineal descendants, and siblings to 5 percent onbequests to distant relatives and those not related to thedecedent. Estates of less than $1,000 were exempted, aswere bequests to the surviving spouse. Bequests to chari-ties were taxed at the top rate, despite pleas from many inCongress that the tax should be used to encourage suchgifts (Office of Tax Analysis, 1963). In addition, the stamptax ranged from 50 cents to $20 on estates valued up to$150,000, with an additional $10 assessed on each $50,000or fraction thereof over $150,000.

Far from a source of controversy, the inheritancetax was praised in the Congressional Globe as a “largesource of revenue, which could be most convenientlycollected” (Office of Tax Analysis, 1963:2). SenatorJames McDougall of California argued that the tax wasthe least burdensome alternative for raising needed rev-enue because “those who pay it, never having had it,never feel the loss of it” (Paul, 1954:15). According toThe Internal Revenue Record, the 1862 tax was “one ofthe best, fairest, and most easily borne [taxes] that po-litical economists have yet discovered as applicable tomodern society” (1869:113).

The mounting cost of the Civil War led to the reen-actment of the 1862 Revenue Act, with some modifica-tions. These changes, established in the Internal Rev-enue Law of 1864, included the addition of a successiontax--a tax on bequests of real property--and an increasein legacy tax rates (see Table 1). In addition, the taxwas applied to any transfers of real property made dur-ing the decedent’s life for less than adequate consider-ation, thus establishing the nation’s first gift tax. Wed-ding gifts were exempted. Transfers of real property tocharities, again, were taxed at the highest rates. Be-quests to widows, but not widowers, were exempt fromthe succession tax, as were bequests of less than $1,000to minor children.

The end of the Civil War and subsequent discharge

Table 1: 1864 De a th Tax Rates

Relationship Rates on Rates on Increase in legacies

real property legacies over 1862

Lineal issue, ancestors 1.00% 1.00% 0.25%S iblings 2.00% 1.00% 0.25%

Descendants of siblings 2.00% 2.00% 0.50%

Uncle, aunt, and their descendants 4.00% 4.00% 1.00%

Great uncle, aunt, and their descendants 5.00% 5.00% 1.00%

Other relatives, not related 6.00% 6.00% 1.00%

Charities 6.00% 6.00% 1.00%



- 6 -

JOHNSON AND ELLER

of the debts associated with the war gradually eliminatedthe need for extra revenue provided by the 1864 Act.Therefore, in 1870, the inheritance tax was repealed (In-ternal Tax Customs Duties Act). The probate tax wasmodified in 1867 to exempt all estates less than $1,000(Internal Revenue Act of 1867), and repealed in 1872(Customs Duties and Internal Revenue Taxes Act).Between 1863 and 1871, the tax had contributed a totalof about $14.8 million to the Federal budget (see Table2, Fiekowski, 1959). In an important victory, the Su-preme Court upheld the constitutionality of the Federalinheritance tax in Scholey v. Revenue Service (1874).The court ruled that the inheritance tax was not a directtax, but an excise tax authorized by Article 1, Section 8

was also advanced in the debates surrounding the struc-ture of the inheritance tax (Paul, 1954).

Inheritance Taxation and the Industrial Revolution

The repeal of the Civil War inheritance tax wasachieved with little public notice. However, inheritanceand the responsibility of government to ensure equalopportunities for its citizenry would invoke intense de-bates by the close of the century. The postwar periodwas one of unprecedented economic and populationgrowth. It was also one that saw enormous changes inthe American way of life. The industrial revolution wasat hand and, as Americans sought the fruits of mass pro-duction, the growth of industry spurred the developmentof large urban centers and provided new jobs for bothnatural born citizens and the ever increasing number ofimmigrants (Bruchey, 1988).

The growth of industrial America and, with it, theprosperity of entrepreneurs who pioneered in the cre-ation of new products and services came at a time whendeclining prices for agricultural products were hurtingAmerican farmers in the West and in the South. Thewealth of the country became increasingly concentratedin the hands of industrialists, as investments in stocksbegan to supplant those in real estate. Because tariffsand real estate taxes formed the basis of governmentfinances at the Federal and State levels, the burden ofsupporting government fell disproportionately on farm-ers, while the wealth of the industrial giants was rela-tively untouched. These events brought about a seriesof important political and social movements, includinga renewed discussion of the institution of inheritance(Paul, 1954).

In Europe, the growing discontent with the concen-tration of national wealth in the hands of a relativelyfew privileged families, and with the perpetuation of thatwealth through bequests, coincided with the rise of com-munism (Chester, 1982). In England, economist JohnStuart Mill (1929) urged limits on the rights of individu-als to bequeath property to heirs. He argued that inher-itance of property had its roots in feudal society whereland was used, but not owned, by the family. The deathof a family member had little effect on the use of theland. This was not the case in “modern” society where

of the Constitution.

The 1864 Act, although altered by subsequent leg-islation, introduced several features, which later formedthe foundation of the modern transfer tax system. Someof these features included the exemption of small es-tates, the taxation of certain lifetime transfers that weretestamentary in nature, and the special treatment of be-quests to the surviving spouse. The idea of using taxpolicy to encourage bequests to charitable organizations

Table 2: Death Tax Receipts, Total Tax Receipts

in the United States, for Fiscal Years 1863-1871

Total tax Death tax Death taxes

Year receipts receipts as a percentage

(millions) (millions) of total taxes

1863 41.0 0.1 0.1%

1864 117.1 0.3 0.3%

1865 211.1 0.5 0.3%

1866 310.9 1.2 0.4%

1867 265.9 1.9 0.7%

1868 191.2 2.8 1.5%

1869 160.0 2.4 1.5%

1870 185.2 3.1 1.7%

1871 144.0 2.5 1.7%



- 7 -


grown children left their parents’ homes and pursuedindependent lives and, therefore, no longer held a claimon their parents’ property. Mill, therefore, proposed “fix-ing a limit to what anyone may acquire by mere favor ofothers without exercise of his facilities,” adding that “ifhe desires any further accession of fortune, he shall workfor it” (Mill, 1994:35). Thus, Mill condoned a gradu-ated tax on inheritances as a proper limiting mechanism.In agreement with Locke and Bentham, he proposedeliminating bequests to non-family members.

In America, the populist movement was also call-ing for limits on inheritance and changes in tax laws tomake the very wealthy “pay their fair share.” Writerssuch as Joseph Kirkland, Mark Twain, William DeanHowells, and others were addressing the evils of capi-talism and the plight of the farmer. Reformers such asJoseph Pulitzer, publisher of the New York World, em-braced the cause of the people rather than that of “purse-proud potentates” (Paul, 1954:30). Pulitzer urged theelimination of tariffs, since tariffs protected businessesand their owners from competition and put the burdenof taxation disproportionately on consumers. That sen-timent was echoed by many in Congress, including Con-gressman Henry George, who advocated an income taxin “an attempt to tax men on what they have, not onwhat they need” (Paul, 1954:31). Other reformers, suchas Charles Bellamy, a utopian socialist writing in 1884,called for limits on inheritance, especially a limit on theamount of property that could be distributed by will(Chester, 1982). “Steep [inheritance] taxes ... woulddecrease the number of social drones,” according to Pro-fessor Gustavus Meyer, author of The Ending of He-reditary American Fortunes. “Heirs would have lessfunds to indulge in lavish expenditures, and the tax bur-den would be shifted from the laboring and consumingpublic” (Office of Tax Analysis, 1963:7). Richard T.Ely, author of Taxation in American States and Cities,hailed the inheritance tax as a tax that was “in accordwith the principles of Jeffersonian Democracy and withthe teachings of some of the best modern thinkers on eco-nomic and social topics” (Office of Tax Analysis, 1963:7).

One of the outstanding proponents of a substantialFederal inheritance tax was industrialist AndrewCarnegie. In his essay, “The Gospel of Wealth,” he ad-vised that “the thoughtful man” would rather leave his

children a curse than the “almighty dollar” (Carnegie,1962:21). The parent who leaves his son enormouswealth generally deadens the talents and energies of theson and tempts the son to lead a less useful and lessworthy life than he otherwise would, according toCarnegie. He did not advocate leveling the wealth dis-tribution, however. Rather, he strongly believed thatindividuals should be encouraged to amass great wealthand spend it, not on opulent living, but on important,carefully planned works for the public good. Carnegiealso advocated a confiscatory inheritance tax, which, hesuggested, would force the wealthy to be more attentiveto the needs of the state--to use their money for noblecauses during their lifetimes. Dismissing arguments thata large inheritance tax would diminish the incentive toaccumulate wealth, Carnegie maintained that, for theclass whose ambition it is to leave great fortunes, “itwill attract even more attention, and, indeed, be a some-what nobler ambition, to have enormous sums paid overto the State from their fortunes” (Carnegie, 1962:22).

Defenders of material accumulation and of the rightto bequeath wealth to successive generations found ref-uge in the philosophy of Social Darwinism. Related tothe writings of the naturalist Charles Darwin, SocialDarwinism was first proposed in England by HerbertSpencer and was later popularized by William GrahamSumner in the United States. Foremost, Sumner arguedthat government should not interfere with an individual’snatural right to struggle for survival. Therefore, he sawno problem with inequalities in the concentration ofwealth that arose through the course of that struggle.Those who wanted either to limit the ability to accumu-late wealth or to limit the amount of that wealth, whichmight be passed on to future generations, were, accord-ing to Sumner, merely envious of the wealthy and hadno right to dictate social policy (Chester, 1982). Sumnerviewed a competitive economy as an essential componentof a democratic society. Indeed, the discipline imposed bycompetition was viewed widely as a necessary mechanismfor the development of character (Bruchey, 1988).

Reformers achieved the passage of the Income TaxAct of 1894. The value of all personal property acquiredby gift or inheritance was included in this graduated tax,which had a top rate of two percent. Critics of the taxheralded it as a blow to American democracy and pre-



- 8 -

JOHNSON AND ELLER

dicted that it would ultimately lead to anarchy. Econo-mist David A. Wells called it “a system of class legisla-tion, full of the spirit of communism,” while the NorthAmerican Review called it the fulfillment of the “wild-est socialist dream” (Paul, 1954:34). The income taxwas quickly appealed to the United States Supreme Courtin the case of Pollock v. Farmers Loan and Trust Com-pany (1895) and declared unconstitutional as anunapportioned direct tax.

Estate Tax of 1898

In 1898, progressive reformers--still stinging fromthe defeat of the Federal income tax--proposed a Fed-eral death tax as a means to raise revenue for the Span-ish-American War. Unlike the two previous Federal in-heritance and probate taxes levied in times of war, the1898 tax proposal provoked heated debate. Supportersof the tax, including Congressman Oscar Underwood ofAlabama, used the debate to further their populist agenda.“The inheritance tax is levied on a class of wealth, aclass of property, and a class of citizens that do not oth-erwise pay their fair share of the burden of government,”Underwood said (Office of Tax Analysis, 1963:11).However, conservatives, such as Congressmen HenryCabot Lodge and Steven Elkins, opposed the tax. Theysuggested that the tax would force businesses to liqui-date their assets and would destroy incentives to accu-mulate wealth, incentives which were essential to thegrowth of capital markets (Paul, 1954).

Despite strong opposition, the inheritance tax wasmade law by the War Revenue Act of 1898. A duty onthe estate itself, not on its beneficiaries, the 1898 taxserved as a precursor to the present Federal estate tax.Rates of tax ranged from 0.75 percent to 15 percent,depending both on the size of the estate and on the rela-tionship of legatee to decedent (see Table 3). Only per-sonal property was subject to taxation. A $10,000 ex-emption was provided to exclude small estates from thetax; bequests to the surviving spouse were also excluded.

In the case Knowlton v. Moore, the U.S. SupremeCourt declared the constitutionality of the 1898 inherit-ance tax. The 1898 Act was amended in 1901 to ex-empt certain gifts from inheritance taxation, includinggifts to charitable, religious, literary, and educational or-ganizations and gifts to organizations dedicated to theencouragement of the arts and the prevention of crueltyto children (War Revenue Reduction Act, 1901). Theend of the Spanish-American War came in 1902, andopponents of the tax wasted no time in exacting its re-peal later that year (War Revenue Repeal Act, 1902).Although short-lived, the tax raised about $14.1 million(see Table 4, Fiekowsky, 1959).

Prelude to the Modern Estate Tax: 1900-1916

The years immediately preceding and following theturn of the 20th century saw an unprecedented numberof mergers in the manufacturing sector of the economy.

Table 3: 1898 Dea th T a x Rate s

$10,000 $25,000 $100,000 $500,000 $1,000,000

Relationship under under under under o r

$25,000 $100,000 $500,000 $1,000,000 more

Lineal issue, ancestors, siblings 0.75% 1.125% 1.50% 1.875% 2.25%

Descendants o f siblings 1.50% 2.25% 3.00% 3.75% 4.50%

Uncle, aunt, and the ir descendants 3.00% 4.50% 6.00% 7.50% 9.00%

Great uncle, aunt, and their descendants 4.00% 6.00% 8.00% 10.00% 12.00%

All others 5.00% 7.50% 10.00% 12.50% 15.00%

No te : Estates under $10,000 were exempt from the tax.



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A new form of ownership, the holding company, caughton and, by 1904, was responsible for 86 percent of largemergers (Bruchey, 1988). The result of these mergerswas a concentration of wealth in a few powerful compa-nies and in the hands of the businessmen who headed them.Along with such wealth came great political power, andthe rise of plutocracy fueled the growth of the progres-sive movement into the early part of the 20th century.

The debate that had surrounded the enactment andrepeal of both the 1894 income tax and the 1898 inher-itance tax gave new credence to the idea of Federal taxesas a means of addressing societal inequalities. Underthe influence of Carnegie and others, the general publicaccepted the notion that large inheritances lead to idle-ness and profligacy, states which contradicted their Pu-ritanical world view. America was founded on the be-lief that each citizen should begin life with an equal op-portunity to succeed and that the economic well-beingof the community required that each member earn hisor her own living (Bittker, 1990). The inheritance taxwas proclaimed an appropriate tool for ensuring the ful-fillment of this manifesto.

By 1906, the progressive movement had an ally inthe White House. President Theodore Roosevelt, in hisannual message to Congress, endorsed an inheritancetax and suggested that its “primary objective should beto put a constantly increasing burden on the inheritanceof those swollen fortunes, which it is certainly of nobenefit to this country to perpetuate” (Bittker, 1990:3).In the spring of that year, he again called for a progres-

sive tax on all fortunes beyond a certain amount, eithergiven during life or devised or bequeathed at death. Thetax would be directed at “malefactors of great wealth,the wealthy criminal class,” according to Roosevelt(Paul, 1954:88). Later in 1906, he endorsed both aninheritance tax and a graduated income tax. However,he was unable to convince a majority of the Congress toenact the reforms (Bittker, 1990).

In 1909, newly elected President Taft, although un-enthusiastic about an income tax, endorsed the inherit-ance tax. A special session of Congress was called inMarch 1909 to address the revenue needs that had arisendue, in part, to the bank panic of 1907. In that session,Representative Sereno Payne, the Republican chairmanof the House Ways and Means Committee, proposed agraduated inheritance tax. The tax was both correct inprinciple and easy to collect, according to Payne (Paul,1954). However, after the enactment of a corporate ex-cise tax, the inheritance tax was dropped by the U.S.Senate. Efforts to enact an income tax that year werealso derailed.

The debate over the institution of inheritance, as wellas debate over the most suitable source of Federal rev-enues, continued until the passage of the 16th Amend-ment to the Constitution. With the 16th Amendmentcame the enactment of the Federal income tax. The es-tablishment of a national income tax served, at least tem-porarily, to pacify the public’s need to redress the in-equalities in wealth, which arose as a result of America’sindustrialization (Office of Tax Analysis, 1963). How-ever, the election of Woodrow Wilson in 1912 wouldserve as a catalyst to the eventual passage of a perma-nent Federal estate tax.

In his inaugural address, President Wilson pledgedto ensure equality of opportunity for every American.According to Wilson, government was an instrument tobe used by people to promote the general welfare (Paul,1954). Espousing that view, he instituted a number ofreforms, including the Clayton Act (1914), which pro-hibited unfair labor practices, and the Federal ReserveAct. Wilson also created the Federal Land Bank, whichmade low interest loans to farmers. He opposed hightariffs and, at the advent of World War I, he moved toeliminate such tariffs on U.S. allies. The elimination of

Table 4: Death Tax Receipts, Total Tax Receipts

in the United States, for Fiscal Years, 1899 - 1902

Total tax Death tax Death taxes

Year receipts receipts as a percentage

(millions) (millions) of total taxes

1899 273.5 1.2 0.5%1900 295.3 2.9 1.0%

1901 306.9 5.2 1.7%

1902 271.9 4.8 1.8%



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JOHNSON AND ELLER

tariffs caused a loss of Federal revenue, a loss that wasamplified by the buildup of armaments and supplies fol-lowing the sinking of the U.S. passenger ship Lusitania.Facing a deficit of $177 million, Congress was forcedto find additional sources of revenue, and, once again, aform of inheritance tax was considered a prime candi-date (Office of Tax Analysis, 1963).

The Modern Estate Tax

In May 1916, Representative Cordell Hull of Ten-nessee introduced a proposal for a Federal estate tax inresponse to what he called “an irrepressible conflict”between the rich and the poor. He suggested that, com-pared to the non-wealthy, the wealthy should pay a largershare of the cost of government. Hull proposed an ex-cise tax on estates prior to the transfer of assets to thebeneficiaries, rather than an inheritance tax. This, ac-cording to Hull, would form “a well-balanced system ofinheritance taxation between the Federal government andthe various States” and could be “readily administeredwith less conflict than a tax levied upon the shares” (Paul,1954:107). While an inheritance tax, with graduatedrates for each recipient, encourages greater dispersionof the estate, the proposed estate tax eliminated the bur-den imposed by an inheritance tax on estates with fewerbeneficiaries (Bittker, 1990).

Understandably, reaction to Hull’s estate tax wasmixed. Having long advocated limits on inheritance,prominent economists such as John A. Ryan, RichardT. Ely, Wilford F. King, and E.R.A. Seligman supportedthe estate tax. In contrast, the New York Times declaredthe tax a “frank project of confiscation.” Harvard econo-mist C.J. Bullock called it a “fiscal crime” (Paul,1954:108). However, on September 8, 1916, Congressenacted an estate tax that would survive, in large part, tothe present (Revenue Act of 1916).

The Revenue Act of 1916

The Federal estate tax was applied to net estates,defined as the total property owned by a decedent, thegross estate, less deductions. While a $50,000 exemp-tion was allowed for all residents, the exemption was

not available to nonresidents owning taxable propertyin the United States. This relatively high filing thresh-old was adopted in deference to the right of States to taxsmall estates. According to the Act of 1916, the grossestate included all property, both personal and real,owned by a decedent; life insurance payable to the es-tate; transfers made for inadequate consideration; trans-fers made in contemplation of death--within two yearsof death; and transfers that took effect on or after death.Also included in the gross estate was all joint property,unless proof could be supplied supporting the contribu-tion of the co-owner. A deduction was allowed for ad-ministrative expenses and losses, debts, claims, and fu-neral costs, as well as for expenses incurred for the sup-port of the decedent’s dependents during the estate’s ad-ministration. The tax rates were graduated from onepercent on the first $50,000 of net estate to ten percenton the portion exceeding $5 million. According to theact, taxes were due one year after the decedent’s death,and a discount of five percent of the amount due wasallowed for payments made within one year of death. Alate payment penalty of six percent was assessed unlessthe delay was deemed “unavoidable.”

The 1916 estate tax was appealed to the United StatesSupreme Court in New York Trust Company v. Eisner.The plaintiff argued that, unlike the earlier inheritancetaxes that applied only to the receipt of property, thenew estate tax was an infringement on the States’ rightto regulate the process of transferring property at death.Justice Oliver Wendell Holmes, in upholding the tax,reasoned that, “if a tax on property distributed by thelaws of a State, determined by the fact that distributionhas been accomplished, is valid, a tax determined by thefact that distribution is about to begin is no greater inter-ference and is equally good” (256 U.S.:348). Thus, theFederal estate tax became a lasting component of theFederal tax system.

Significant Tax Law Changes: 1916 to Present

Since its inception in 1916, the basic structure ofthe modern Federal estate tax, as well as the law fromwhich it is derived, has remained largely unchanged.However, in the eight decades that followed the Rev-



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enue Act of 1916, the U.S. Congress has enacted sev-eral important additions to, and revisions of, the mod-ern estate tax structure (see Figure 1). There have alsobeen occasional adjustments to the filing thresholds, taxbrackets, and marginal tax rates (see Table 5). The firstsuch addition was a tax on inter vivos gifts, a gift tax,introduced by the Revenue Act of 1924. The new taxwas imposed because Congress realized that wealthy in-dividuals could avoid the estate tax, invoked at death,by transferring wealth during their lifetimes. That is,due to inter vivos giving, the estate tax’s inherent ca-pacity to redistribute wealth accumulated by large es-tates was effectively circumvented, and a source of rev-enue was removed from the Federal government’s reach.The Congressional response was a gift tax applied tolifetime transfers.

The first Federal gift tax was short-lived, however.Due to strong opposition to estate and gift taxes duringthe 1920’s, the gift tax was repealed by the RevenueAct of 1926 (Zaritsky and Ripy, 1984). Then, just sixyears later, when the need to finance Federal spendingduring the Great Depression outweighed opposition togift taxation, the Federal gift tax was reintroduced bythe Revenue Act of 1932 (Zaritsky and Ripy, 1984). Adonor could transfer $50,000 free of tax over his or herlifetime with a $5,000-per-donee annual exclusion fromgift tax.

The Revenue Act of 1935 introduced the optionalvaluation date election. While the value of the grossestate at the date of death determined whether an estatetax return had to be filed, the act allowed an estate to bevalued, for tax purposes, one year after the decedent’sdeath. With this revision, for example, if the value of adecedent’s gross estate dropped significantly after thedate of death--a situation faced by estates during theDepression--the executor could choose to value the es-tate at its reduced value after the date of death. Theoptional valuation date, today referred to as the alter-nate valuation date, was later changed to six months af-ter the decedent’s date of death.

Most outstanding among the pre-1976 changes toestate tax law was the estate and gift tax marital deduc-tions, as well as the rule on “split gifts” introduced by

the Revenue Act of 1948. Indeed, the estate tax maritaldeduction, as enacted by the 1948 Act, permitted adecedent’s estate to deduct the value of property pass-ing to a surviving spouse, whether passing under thewill or otherwise (Zaritsky and Ripy, 1984). However,the deduction was limited to one-half of the decedent’sadjusted gross estate--the gross estate less debts and ad-ministrative expenses. In a similar manner, the gift taxmarital deduction allowed a “donor [spouse] to deductone-half of the interspousal gift, other than a gift of com-munity property” (Zaritsky and Ripy, 1984:16). Fur-ther, the Act of 1948 introduced the rule on “split-gifts,”which permitted a non-donor spouse to act as donor ofhalf the value of the donor spouse’s gift. The rule onsplit gifts effectively permitted a married couple to trans-fer twice as much wealth tax free in a given year.

With few other exceptions, the CongressionalRecord remained free of reference to the estate tax andthe entire transfer tax system until the enactment of theTax Reform Act (TRA) of 1976. By creating a unifiedestate and gift tax framework that consisted of a “single,graduated rate of tax imposed on both lifetime gift andtestamentary dispositions” (Zaritsky and Ripy, 1984: 18),the act eliminated the cost differential that had existedbetween the two types of giving. Prior to the act, “itcost substantially more to leave property at death thanto give it away during life” (Bittker, 1990:20) due to thelower tax rate applied to inter vivos gifts. The Tax Re-form Act of 1976 also merged the estate tax exclusionand the lifetime gift tax exclusion into a “single, unifiedestate and gift tax credit, which may be used to offsetgift tax liability during the donor’s lifetime but which, ifunused at death, is available to offset the deceaseddonor’s estate tax liability” (Zaritsky and Ripy, 1984:18).An annual gift exclusion of $3,000 per donee was re-tained.

The 1976 tax reform package also introduced a taxon generation-skipping transfers (GST’s). Prior to pas-sage of the act, a transferor, for example, could create atestamentary trust and direct that the income from thetrust be paid to his or her children during their lives andthen, upon the children’s deaths, that the principal bepaid to the transferor’s grandchildren. The trust assetsincluded in the transferor’s estate would be taxed upon



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JOHNSON AND ELLER

1916 - Estate tax enacted

1924 - Gift tax enacted State death tax credit Revokable transfers included

1926 - Gift tax repealed1932 - Gift tax reintroduced Additional estate tax

1935 - Alternate valuation

1948 - Marital deduction replaced 1942 community prop. rules

1976 - Unified estate and gift tax Generation-skipping transfer tax (GST) Orphan deduction Carryover basis rule Special valuation and payment rules for small business and farms Increased marital deduction

1980 - Carryover rule repealed1981 - Unlimited marital deduction Full value pension benefits, but only 1/2 joint property included Orphan deduction repealed 1986 - ESOP deduction

GST modified

1987 - Phaseout of graduated rates and unified credit for estates over $10 million

1988 -QTIP allowed for marital deduction Estate freeze and GST modified

1989 - ESOP deduction dropped

1990 - Estate freeze rules replaced

1954 - Most life insurance, unless decedent never owned, included

Figure 1: Significant Tax Law Changes, 1916 - 1995

1995

1918 - Spouse's dower rights, Exercised general powers of appointment, and Insurance payable to estate and insurance over 40,000 to beneficiaries included Charitable deduction

1942 - Insurance paid for by decedent, Powers of appointment (not limited) and

Community property unless spouse contributed included

1951 - Powers of appointment rule relaxed



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Table 5: Estate Tax Law Changes Affecting Filing Requirements and Tax Rates, 1916-1995Basic tax Supplemental tax

Year Exemption Initial rate Top rate Top bracket Exemption Initial rate Top rate Top bracket

1916 50,000 1 10 5,000,000

1917 50,000 2 25 10,000,000

1918-23 50,000 1 25 10,000,000

1924-25 50,000 1 40 10,000,000

1926-31 100,000 1 20 10,000,000

1932-33 100,000 1 20 10,000,000 50,000 1 45 10,000,000

1934 100,000 1 20 10,000,000 50,000 1 60 10,000,000

1935-39 100,000 1 20 10,000,000 40,000 2 70 50,000,000

1940 a 100,000 1 20 10,000,000 40,000 2 70 50,000,000

1941 100,000 1 20 10,000,000 40,000 3 77 10,000,000

1942-53 100,000 1 20 10,000,000 60,000 3 77 10,000,000

1954-76 60,000 3 77 10,000,000

1977 b 120,000 18 70 5,000,000

1978 134,000 18 70 5,000,000

1979 147,000 18 70 5,000,000

1980 161,000 18 70 5,000,000

1981 175,000 18 70 5,000,000

1982 225,000 18 65 4,000,000

1983 275,000 18 60 3,500,000

1984 325,000 18 55 3,000,000

1985 400,000 18 55 3,000,000

1986 500,000 18 55 3,000,000

1987-95 c,d 600,000 18 55 3,000,000

a. 10% war surtax added.b. Unified credit replaces exemption.c. Tax rate was to be reduced to 50% on amounts beginning in 1988, but was postponed until 1992, then repealed retroactively in 1993 and set permanently to the 1987 levels.d. Graduated rates and unified credits phased out for estates over $10,000,000.



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JOHNSON AND ELLER

the transferor’s death. Then, any trust assets includedin the grandchildren’s estates would be taxed at theirdeaths. However, the intervening beneficiaries, thetransferor’s children in this example, would pay no es-tate tax on the trust assets, even though they had en-joyed the interest income derived from those assets.Congress responded to the GST tax leakage in the TaxReform Act of 1976. The act added a series of rules,applied to GST’s valued at more than $250,000, whichwere designed to treat the termination of the interven-ing beneficiaries’ interests as a taxable event (Zaritskyand Ripy, 1984). In 1986, Congress simplified the GSTtax rates and increased the amount a grantor could trans-fer into a GST tax free, from $250,000 to $1 million.As with the gift tax exclusion, “married persons maycombine their [GST tax] exemptions, thus allowing thecouple a $2,000,000 exemption” (Bittker 1990:31).Overall, the GST tax “ensures that the transmission ofhereditary wealth is taxed at each generation level”(Bittker, 1990: 30).

The Economic Recovery Tax Act (ERTA) of 1981brought several notable changes to estate tax law. Priorto 1982, the marital deduction was permitted only fortransfers of property in which the decedent’s survivingspouse had a terminable interest--an interest that grantsthe surviving spouse power to appoint beneficiaries ofthe property at his or her own death. Such property is,ultimately, included in the surviving spouse’s estate.However, the ERTA of 1981 allowed the marital de-duction for life interests that were not terminable, as longas the property was “qualified terminable interest prop-erty” (QTIP), defined as “property in which the [surviv-ing] spouse has sole right to all income during his or herlife, payable at least annually, but no power to transferthe property at death” (Johnson, 1994:60). To utilizethe deduction, however, the QTIP must be included inthe surviving spouse’s gross estate. The 1981 Act alsointroduced unlimited estate and gift tax marital deduc-tions, thereby eliminating quantitative limits on theamount of estate and gift tax deductions available forinterspousal transfers.

The ERTA of 1981 increased the unified transfertax credit, the credit available against both the gift andestate taxes. The increase, from $47,000 to $192,800,was to be phased in over six years, and the increase would

effectively raise the tax exemption from $175,000 to$600,000 over the same period (Johnson, 1990:20). TheERTA of 1981 also raised the annual gift tax exclusionto $10,000 per donee; an unlimited annual exclusionfrom gift tax was allowed for the payment of a donee’stuition or medical expenses (Bittker, 1990). Finally,through ERTA, Congress enacted a reduction in the topestate, gift, and generation-skipping transfer tax ratesfrom 70 percent to 50 percent, applicable to transfersgreater than $2.5 million. The reduction was to be phasedin over a four-year period. However, later legislation--both the Deficit Reduction Act of 1984 and the Rev-enue Act of 1987--delayed the decrease in the top taxrate from 55 percent to 50 percent until after December31, 1992. Then, in 1993, Congress again revised thetop tax rate schedule, imposing a marginal tax rate of 53percent on taxable transfers between $2.5 million and$3 million and a maximum marginal tax rate of 55 per-cent on taxable transfers exceeding $3 million. Thehigher rates were applied retroactively to January 1, 1993(Legislative Affairs, 1993).

The Revenue Act of 1987, also called the OmnibusBudget Reconciliation Act of 1987, introduced legisla-tion to eliminate estate tax avoidance schemes knownas “estate freezes.” An estate freeze “involved divisionof ownership of a business into two parts: a frozen in-terest and a growth interest” (Miller, 1988:1336). Byselling or giving away the growth interest, the interestthat held the potential for becoming valuable if the busi-ness prospered, “a taxpayer could maintain control ofthe business and continue to enjoy the income from thebusiness while excluding any future appreciation in itsvalue from his gross estate” (Miller, 1988:1336). The1987 legislation mandated treating the transferor’s fro-zen interest as a retained life estate in the growth inter-est that was transferred. Therefore, the growth interestwould be included in the owner’s gross estate upon hisor her death. In 1988, with the passage of the Technicaland Miscellaneous Revenue Act, Congress revised itsantifreeze legislation to include a different, and stricter,approach toward the valuation of business interests trans-ferred prior to death (Miller, 1988). These rules, how-ever, proved to be too restrictive. The Revenue Recon-ciliation Act of 1990 repealed all prior estate-freeze leg-islation and, in its place, substituted strengthened gifttax rules dealing with the valuation of the growth inter-



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est at the time of the transfer. The 1990 Act also estab-lished specific rules for valuing the retained interest forestate tax purposes (Johnson, 1994).

Current Estate Tax Law

According to current estate tax law, a Federal estatetax return must be filed for every deceased U.S. citizenwhose gross estate valued on the date of death, com-bined with adjusted taxable gifts made by the decedentafter December 31, 1976, and total specific exemptionsallowed for gifts made after September 8, 1976, equalsor exceeds $600,000. The estates of nonresident aliensmust also file if property held in the United States ex-ceeds $60,000. All of a decedent’s assets, as well as thedecedent’s share of jointly owned and community prop-erty assets are included in the gross estate for tax pur-poses. Also considered are most life insurance proceeds,property over which the decedent possessed a generalpower of appointment, and certain transfers made dur-ing life that were (1) revokable or (2) made for less thanfull consideration. An estate is allowed to value assetson a date up to six months after a decedent’s death if thevalue of assets declined during that period. Special valu-ation rules and a tax deferment plan are available to anestate that is primarily comprised of a small business orfarm.

Expenses and losses incurred in the administrationof the estate, funeral costs, and the decedent’s debts areallowed as deductions against the estate for the purposeof calculating the tax liability. A deduction is also al-lowed for the full value of bequests to the survivingspouse, including bequests in which the spouse is givenonly a life interest, subject to certain restrictions. Be-quests to charities are also fully deductible. A unifiedtax credit of $192,800 is allowed for every decedentdying after December 31, 1986. Credits are also allowedfor death taxes paid to States and other countries, as wellas for any gift taxes the decedent may have paid duringhis or her lifetime. The estate tax return (Form 706)must be filed within nine months of the decedent’s deathunless a six-month extension is requested and granted.Taxes owed for generation-skipping transfers in excessof the decedent’s $1-million exemption and taxes oncertain retirement fund accumulations are due concur-rent with any estate tax liability. Interest accumulated

on U.S. Treasury bonds redeemed to pay these taxes isexempt from taxation.

Transfer Taxes and Estate Planning

As the Federal transfer tax system has become morecomplex, individuals have increasingly turned to estateplanners for tax minimization strategies. Estate plan-ners, in turn, keep their clients apprised of tax lawchanges, which may have an adverse effect on testa-mentary arrangements already in place. This has madeestate-planning more of a process than a one-time event.Tax law provisions can have a significant impact on boththe ownership of assets during one’s lifetime and thedisposition of an estate at death. Occasionally, legisla-tive intervention is specifically intended to influencebequest patterns. Such was the case with the enactmentof the generation-skipping transfer tax. In other in-stances, changes in the tax code seeking to provide re-lief to specific segments of the population or those madein response to revenue needs will have a bequest effect.Allowable deductions, tax credits, and tax rates all playa role in bequest decisions.

Tax law changes associated with the Economic Re-covery Tax Act (ERTA), which applied to decedentsdying on or after January 1, 1982, provided for an un-limited deduction from the value of the gross estate forbequests to a surviving spouse; prior to that, the deduc-tion was limited to one-half the adjusted gross estate.Figure 2 shows the full value of property bequeathed tosurviving spouses as a percentage of the decedents’ dis-tributable estates (total gross estate less expenses; debts;and Federal, State, and foreign death taxes) for selectedyears between 1972 and 1992. The percentage rises fromabout 60 percent prior to 1982 to about 70 percent after1982 and passage of ERTA. This suggests a significantchange in bequest behavior among married persons, withmore property passing to the surviving spouse and, per-haps, a reduction in the amount bequeathed to others,including children and charities. Careful estate plan-ning, however, may allow a decedent to take advantageof tax avoidance strategies and maintain his or her be-quest goals. A popular strategy is to form a trust knownas an “A-B trust.” Here, the estate planner creates onetrust in the amount of the decedent’s tax exemption($600,000), sometimes called a Unified Credit Trust, and



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JOHNSON AND ELLER

puts the rest of the estate into a second, usually larger,QTIP (Qualified Terminable Interest Property) trust.Income from both trusts is directed to the survivingspouse for life. However, the smaller trust is really setaside for the children. The surviving spouse is typicallygiven more access to the principal of the second trustand may have limited powers to appoint beneficiaries.Upon the death of the second spouse, the remainderpasses to the children. Thus, the first decedent takesadvantage of the unlimited marital deduction but ensuresthat the children will eventually benefit from the estate.

The value of property bequeathed to charities, aswell as the number of decedents making gifts to chari-ties, declined after ERTA (see Figure 3). This may rep-resent a shift in bequests from charities to the survivingspouse as a result of the unlimited marital deduction. A

reduction in the top tax rate from 77 percent and in-creases in the unified credit since 1977 may also ex-plain the decrease in charitable bequests. Studies ofcharitable giving at death have shown that tax rates seemto exert an influence on the size of charitable bequests,as well as on the number of charitable organizationsnamed as beneficiaries (Joulfaian, 1991). This is so be-cause the amount of tax savings attributable to the de-duction decreases as rates decline. Charitable bequestsfrom decedents with relatively small- and medium-sizedestates seem particularly sensitive to changes in the ratestructure (Boskin, 1976; Clotfelter, 1985).

Federal estate taxes also encourage individuals tobegin transferring wealth well before death in order tominimize the size of their estates. Lifetime giving maybe an important component of an individual’s overall

Figure 2: Marital Bequests as a Percentage of Distributable Estate, 1972 -1995, for Married Decedents with Estates of $600,000 or More in Constant 1987 Dollars

1972 1976 1982 1986 1989 1993 19950

20

40

60

80

Filing yearNote: Distributable estate is total gross estate, less expenses, debts, and Federal, State, and foreign death taxes.

Percent



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bequest strategy. Federal gift tax law allows a donor tomake annual gifts up to $10,000 per donee without in-curring a transfer tax liability; married couples are al-lowed up to $20,000 per donee. Children are usuallythe primary recipients of these transfers. There are avariety of trust instruments and financial arrangementsthat may be used in conjunction with gift giving to re-move assets from the estate. These affect the timingand the amount of the tax liability, as well as the typesof assets and degree of ownership eventual beneficia-ries receive.

Current Transfer Taxation: Criticismsand Proposals

Eight decades since the introduction of the modernFederal estate tax, and two centuries since discussionsof inheritance and taxation first appeared in America,

the current transfer tax system, including estate, gift, andgeneration-skipping transfer taxes, remains a topic ofCongressional, academic, and popular discourse. Fur-ther, the fundamental tenets of current discussions findtheir roots in the historic arguments of early thinkers,such as Adam Smith, David Ricardo, and JeremyBentham. Although the transfer tax system is often citedas a negative influence on the accumulation of capitalstock in the U.S. economy, as well as a negative influ-ence on the vitality of small business, the system is pre-served in a form that differs little from its origins.

The scope of the transfer tax system, as measuredby Federal revenue flows, is quite narrow. While it isreasonable to argue that a Federal tax is levied, at leastin part, for its contribution to Federal budget inlays, therevenue derived from estate and gift taxes does not con-tribute significantly to total budget receipts. “Taxes on

Figure 3: Charitable Bequest Data, 1962-1995, for Estates of $600,000 or More in Constant 1987 Dollars

Note: Distributable estate is total gross estate, less expenses, debts, Federal, State, and foreign death taxes

1962 1965 1969 1972 1976 1982 1986 1989 1993 19950

5

10

15

20

25

Filing year

Donors as a percentage of all filers

Bequests as a percentage of distributable estate

Percent



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JOHNSON AND ELLER

property transfers have never provided significant rev-enues in this country and have been reduced to an insig-nificant proportion in recent years,” according to econo-mist Joseph A. Pechman, former senior fellow at theBrookings Institution (1983:226; see Figure 4). Withfew exceptions, revenue from Federal estate and gifttaxes has lingered between one and two percent of Fed-eral budget receipts since World War II, reaching a post-war high of 2.6 percent in 1972. Recent data also dem-onstrate the small role that transfer taxes play as sourcesof Federal revenue. In 1994, as well as in the precedingfour years, Federal estate and gift taxes made up onlyone percent of budget receipts.

The scope of the transfer tax system, as measuredby the size of the population directly affected by thesystem, is also quite narrow (see Table 6). The numberof estate tax filers with taxable estates--filers who in-curred a tax liability--reached a high of 139,115 in 1976;

the estate tax exemption in that year was $60,000. Sincethe introduction of the $600,000-estate and gift tax ex-emption in 1987, the annual number of taxable estatetax returns has not exceeded 32,000. In 1994, 31,918taxable estate tax returns were filed for decedents, a num-ber that represents only 1.4 percent of the adult deathsthat occurred in that year, according to preliminary 1994death statistics by the National Center for Health Statis-tics (see Table 6 footnote). The number of estate taxdecedents with tax liabilities during 1995 was 31,692.Preliminary estimates for the number of adult deaths for1995 are not available.

Clearly then, the transfer tax system neither providesa significant portion of Federal budget inlays nor sub-jects a significant portion of the U.S. population to Fed-eral taxation. For these and other reasons, the system isthe object of much criticism. The assertion that the es-tate tax is a “voluntary tax,” a term first employed by

1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 19950

2

4

6

8

10

Figure 4: Estate and Gift Taxes as a Percentage of Total Federal Receipts, 1917-1995

Percent

Filing year



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Table 6: Estate Tax Returns as a Percentage of Adult Deaths,Selected Years of Death, 1934-1993

(Starting with 1965, number of returns is based on sample estimates)

Taxable estate tax returnsSelected year Total Percentage

of death adult deaths a Number of adult deaths (1) (2) (3)

1934 983,970 8,655 0.881935 1,172,245 9,137 0.781936 1,257,290 12,010 0.961937 1,237,585 13,220 1.071938 1,181,275 12,720 1.081939 1,205,072 12,907 1.071940 1,237,186 13,336 1.081941 1,216,855 13,493 1.111942 1,211,391 12,726 1.051943 1,277,009 12,154 0.951944 1,238,917 13,869 1.121946 1,239,713 18,232 1.471947 1,278,856 19,742 1.541948 1,283,601 17,469 1.361949 1,285,684 17,411 1.351950 1,304,343 18,941 1.451953 1,237,741 24,997 2.021954 1,332,412 25,143 1.891956 1,289,193 32,131 2.491958 1,358,375 38,515 2.841960 1,426,148 45,439 3.191962 1,483,846 55,207 3.721965 1,578,813 67,404 4.271969 1,796,055 93,424 5.201972 1,854,146 120,761 6.511976 1,819,107 139,115 7.651982 1,897,820 34,446 1.821983 1,945,913 34,883 1.791984 1,968,128 30,447 1.551985 2,015,070 22,324 1.111986 2,033,978 21,939 1.081987 2,053,084 18,059 0.881988 2,096,704 20,751 0.991989 2,079,035 23,002 1.111990 2,079,034 24,456 1.181991 2,101,746 26,277 1.251992 2,111,617 27,243 1.291993 b 2,168,120 32,002 1.48

a. Total adult deaths represent those of individuals age 20 and over, plus deaths for w hich age w as unavailable.For 1993, total deaths are for adults age 25 and older and for the 12-month period ending w ith November.b. PreliminarySOURCE: For years after 1953, STATISTICS OF INCOME-ESTATE TAX RETURNS; ESTATE AND GIFT TAX RETURNS; FIDUCIARY, ESTATE, AND GIFT TAX RETURNS; and unpublished tabulations, depending on the year. For years prior to 1954, STATISTICS OF INCOME - PART I. Adult deaths are from the National Center for Health Statistics, PublicHealth Service, U.S. Department of Health and Human Services, VITAL STATISTICS OF THE UNITED STATES, unpublished tables.



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JOHNSON AND ELLER

Columbia law professor George Cooper in his 1979 studyof estate-planning techniques, is foremost among thecriticisms of the tax. By labeling the estate tax “volun-tary,” Cooper suggests that, far from imposing an un-avoidable tax, estate tax law really provides numerousmethods for tax avoidance. Today, tax avoidanceschemes fall into three basic categories. First, the “tech-nique of estate freezing keeps free of tax the futuregrowth in an individual’s wealth by diverting that growthto the next generation” (Cooper, 1979: 4). Second, the“creation of tax-exempt wealth takes advantage of spe-cial provisions in the tax code that exempt certain assetsfrom taxation” (Cooper, 1979:4). Finally, the “reduc-tion or elimination of tax on existing wealth is madepossible by a package of techniques for gift-giving,manipulating valuations, and exploiting charitable de-ductions” (Cooper, 1979:5). Cooper concludes that,“because estate tax avoidance is such a successful andyet wasteful process, ... the present estate and gift taxserves no purpose other than to give reassurance to themillions of unwealthy that entrenched wealth is beingattacked” (82), reassurance which, he later suggests, ismerely superficial. The annual costs of estate tax avoid-ance schemes, including lawyer fees, accountant fees,costs of subscriptions to estate planning magazines, andopportunity costs of individuals involved in tax avoid-ance activities, have been shown to represent a largepercentage of the annual receipts from estate and gifttaxes. A 1988 study showed that tax avoidance costsapproach billions of dollars annually, which, accordingto the study’s researchers, represent “an inordinately highsocial cost for a tax that only yielded $7.7 billion in 1987”(Munnell, 1988:19).

Our present system of taxing wealth transfers is alsocriticized for its effect on capital accumulation in theU.S. economy. In his examination of the Federal trans-fer tax system, Richard Wagner (1993), professor ofeconomics, suggests that, “by reducing the incentive thatpeople have to save and invest, transfer taxation reducescapital formation, which, in turn, reduces wages and jobcreation from what they would otherwise be” (6). Thisargument echoes one asserted by Adam Smith in thelate 18th century and David Ricardo in the early 19thcentury. Indeed, according to both of these early econo-mists, transfer taxes decrease investment in capital and,thereby, decrease productivity and wages as heirs are

forced to liquidate business assets to pay the tax. In hisstudy of the social costs of transfer taxation in the UnitedStates, Wagner estimated that, in the absence of Federaltransfer taxation since 1971, jobs would have increasedby 262,000, capital investment would have increasedby $399 billion, and gross domestic product would haveincreased by $46 billion.

Federal transfer taxes are often cited as impedimentsto the livelihood of small businesses and farms. Indeed,“small businessmen and farmers have always felt thatthe estate tax is especially burdensome” (Pechman,1983:242), given that their estates may consist of littlemore than their businesses. These businessmen, and theirCongressional representatives, assert that “heavy taxa-tion or a rule requiring payment of taxes immediatelyafter the death of the owner-manager would necessitateliquidation of the enterprise and loss of the business bythe family” (Pechman, 1983:242). Congress has re-sponded to such concerns by introducing certain tax-relief provisions. In 1976, for example, Congress sug-gested that “additional relief should be provided to es-tates with [liquidity] problems arising because a sub-stantial portion of the estate consists of an interest in aclosely held business or other illiquid assets” (SenateReport, 1976). Thus, in 1976, Code Section 6166 waspassed. Under 6166, an executor is permitted to “electto pay the Federal estate tax attributable to an interest ina closely held business in installments over, at most, a14-year period” (Beerbower, 1995:5).

During 1995 and 1996, the impact of estate taxationon small business, and other estate tax issues, includingthe very existence of the tax, were once again topics ofdiscussion in Congress, as well as in the 1996 Presiden-tial election. Several bills addressing the Federal estatetax were introduced during the 104th Congress, 1995-1996. In April 1995, the U.S. House of Representativespassed one such bill, H.R. 1215, a proposal to increasethe unified credit against the estate and gift tax, as wellas to provide a cost-of-living adjustment for such cred-its (U.S. Library of Congress, 1996). In addition, thebill proposed to provide an “inflation adjustment for thealternate valuation of certain farm and business prop-erty, the gift tax exclusion, the generation-skipping taxexemption, and the estate tax on closely held businesses”(Library of Congress, 1996). The bill called for a gradual



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rise in the unified credit and, therefore, a gradual rise inthe effective exclusion for estate and gift tax purposes,from the current $600,000 to $700,000 in 1996, $725,000in 1997, and $750,000 in 1998, after which the exclu-sion would be adjusted for inflation. Although the Sen-ate Finance Committee held hearings on the measure,the Senate did not pass a bill.

Congress submitted other similar bills during its104th session. H.R. 62, while never passed, sought “toincrease the unified estate and gift tax credit to an amountequivalent to a $1,200,000 exemption” (Library of Con-gress, 1996). The Senate considered S.628, the FamilyHeritage Preservation Act. That bill proposed a com-plete repeal of Federal estate, gift, and generation-skip-ping transfer taxes. While introducing the bill to thelegislative body, the senate sponsor of S.628 called theFederal estate tax “one of the most wasteful and unfairtaxes currently on the books,” further suggesting thatthe tax “penalizes people for a lifetime of hard work,savings, and investment.” The tax “hurts small busi-ness and threatens jobs ... {and} causes people to spendtime, energy, and money finding ways to avoid the tax,”said the senate sponsor.

The 1996 Presidential election also served as a fo-rum for discussion of the Federal estate tax. The needfor estate tax relief was among the campaign themes ofRepublican presidential nominee Robert “Bob” Dole.At a campaign rally in Alamogordo, New Mexico, inearly November 1996, Dole addressed the tax on deathtransfers. “[F]or those who work all their lives--kidswork, the wife works, the husband works, you scrimpand save, and you finally have a little business or a littlefarm or a little ranch, and somebody passes on,” Dolesaid, according to the Federal News Service. “We don’tthink you should have to sell part of the ranch to pay theestate taxes. We’re going to start providing estate taxrelief,” he added. Dole and his running-mate, JackKemp, outlined a 14-point pledge that contained a prom-ise to “increase the estate tax exemption from $600,000to $1.6 million and eventually eliminate the estate taxon family-owned businesses, farms, and ranches,” ac-cording to U.S. Newswire.

During the first term of his administration, Presi-dent Bill Clinton supported modification, not the com-

plete elimination, of the Federal estate tax. At hearingsbefore the Senate Finance Committee in June 1995, then-Deputy Assistant Secretary of Tax Policy at the Trea-sury Department, Cynthia G. Beerbower, said that theClinton administration “recognizes that the levels of theunified credit and various other estate and gift tax limi-tations have not been increased since 1987” (Beerbower,1995:5). The administration is “willing to work withCongress to maintain an estate and gift tax system thatexempts small- and moderate-sized estates, and that helpskeep intact small and family businesses, so that they canbe passed on to future generations” (1995:6), accordingto Beerbower.

In November 1996, the Clinton administration wona second term in office, and the Republicans retainedthe majority in Congress. These events, and recent ne-gotiations about filing thresholds, tax brackets, and mar-ginal tax rates in the Federal transfer tax system, sug-gest that the system will continue to find a place in na-tional dialogue.

Conclusion

Today, some tax theorists work to convince Con-gress that transfer taxes should play a larger role in theFederal revenue system because, they argue, “death taxeshave less adverse effects on incentives than do incometaxes of equal yield” (Pechman, 1983:225). Indeed,“income taxes reduce the return from effort and risk tak-ing as income is earned,” according to Pechman, whereas“death taxes are paid only after a lifetime of work andaccumulation and are likely to be given less weight byindividuals in their work, saving, and investment deci-sions” (1983:226). There are economists who also re-ject the postulate that moderate transfer taxes have anadverse effect on capital accumulation. Embracing anidea first proposed by the mid-19th century Englisheconomist J.R. McCulloch, they argue that transferorsadjust their bequest plans when faced with transfer taxes(Fiekowski, 1959). According to McCulloch, the deathtax causes individuals who plan to make significant be-quests to increase savings so that their heirs can pay thetaxes without adversely affecting the transferred assets.When transfers involve business assets, McCullochmight have argued, a testator would ensure the continu-



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JOHNSON AND ELLER

ance of a business by increasing the bequest amount inorder to cover the cost of transfer taxes.

Still, Congress and the public seem hesitant to in-crease the scope of the transfer tax system. “The equal-ization of the distribution of wealth by taxation is notyet accepted in the United States,” suggests Pechman(1983:227). Chester (1982) attributes this to what hecalls the “lottery phenomenon: the strong desire of themajority of Americans to have a chance to ‘win big’ byinheriting wealth, thus vaulting without exertion abovethe mass of men” (51). Pechman also suggests thatmisconceptions regarding the scope of transfer taxes mayalso be a factor. “[E]state and gift taxes are erroneouslyregarded as especially burdensome to the family that isbeginning to prosper through hard work and saving,”according to Pechman, who further suggests that “themerits of wealth transfer taxes will have to be morewidely understood and accepted before they can becomeeffective revenue sources” (1983:227).

More than 300 years after John Locke and his con-temporaries sought to define the relationship betweencivil government and the governed, Americans strugglefor consensus concerning government’s ideal role in theregulation of wealth transfers. There is resentment overthe use of transfer taxes as a source of revenue and as atool for influencing the distribution of personal wealth.There is also the belief that the revenue and redistribu-tive goals of transfer taxes are entirely appropriate to analtruistic nation that promotes the welfare of its citizens.Even economists are divided. Neoclassical economistsassert that the disruption to businesses resulting fromtransfer taxes has cost the economy billions of dollarsin lost productivity and hundreds of thousands of newjobs. Yet, many tax economists argue that transfer taxesare less harmful than income taxes and have great ap-peal “ on social, moral, and economic grounds”(Pechman, 1983:226). Disputes over the economic ef-fects and propriety of transfer taxes have spanned manycenturies, and the fervor on which those disputes arefounded is no less present today.

References

Beerbower, Cynthia G. (1995), Statement of Cynthia

G. Beerbower, Deputy Assistant Secretary (TaxPolicy) Department of the Treasury, before theSenate Finance Committee, Washington, D.C.:Office of Public Affairs.

Bittker, I. and Clark, E. (1990), Federal Estate andGift Taxation, Boston, MA: Little, Brown, and Company.

Boskin, M.J. (1976), Estate Taxation and CharitableBequests, Journal of Public Economics, 5, 27-56.

Bruchey, S. (1988), The Wealth of the Nation, NewYork: Harper and Row.

Carnegie, A. (1962), The Gospel of Wealth and OtherTimely Essays, Cambridge, MA: The BelknapPress of Harvard University Press.

Chester, R. (1982), Inheritance, Wealth, and Society,Bloomington, IN: Indiana University Press.

Clotfelter, C.T. (1985), Federal Tax Policy andCharitable Giving, Chicago, IL: University ofChicago Press.

Cooper, George (1979), A Voluntary Tax? Washing-ton, D.C.: The Brookings Institution.

Customs Duties and Internal Revenue Taxes Act of1872 §36, 17 Stat 256.

Economic Recovery Tax Act of 1981, Public Law 97-34.

Eyre v. Jacob, 14 Grat. 422 (1858).

Fiekowsky, Seymour (1959), On the Economic Effectsof Death Taxation in the United States, doctoraldissertation, Harvard University, Cambridge, MA.

In the News, 4 November 1996, Federal News Service.

Income Tax Act of 1894, 28 Stat. 509, 553.

Internal Revenue Act of 1867, 14 Stat. 169.



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Internal Revenue Law of 1864 §124-150, 13 Stat. 285.

Internal Taxes, Customs Duties Act of 1870 §27, 16Stat. 269.

IRS Legislative Affairs, 17 September 1993, draft.

Johnson, B.W. (1994), Estate Tax Returns, 1989-1991, Compendium of Federal Estate Tax andPersonal Wealth Studies, Washington, D.C.: U.S.Government Printing Office.

Joulfaian, D. (1991), Charitable Bequests and EstateTaxes, National Tax Journal, 44(2), 169-180.

Knowlton v. Moore, 178 U.S. 41 (1900).

Locke, J. (1988), Two Treatises of Government,Cambridge: Cambridge University Press.

Mager v. Grima, 49 U.S. 490 (1850).

Miller, John A. (1988), Gift Wrapping the EstateFreeze, Tax Notes, December 19, 1135-1341.

Mill, J.S. (1994), Principles of Political Economy andChapters on Socialism, Oxford: Oxford Univer-sity Press.

Munnell, Alicia H. (1988), Wealth Transfer Taxation:The Relative Role for Estate and Income Taxes,New England Economic Review, November/December, 3-26.

New York Trust Company v. Eisner, 256 U.S. 345.

Office of Tax Analysis (1963), Legislative History ofDeath Taxes in the United States, unpublishedmanuscript.

Paul, R.E. (1954), Taxation in the United States,Boston, MA: Little, Brown, and Company.

Pechman, Joseph A. (1983), Federal Tax Policy,Washington, D.C.: The Brookings Institution.

Pollock v. Farmers Loan and Trust Company, 158U.S. 601 (1895).

Ricardo, D. (1819), On The Principles of PoliticalEconomy and Taxation, Georgetown, D.C.:Joseph Milligan.

Revenue Act of 1916, 39 Stat. 756.






Revenue Act of 1987, Public Law 100-203.

Revenue Reconciliation Act of 1990, Public Law 101-508.

Scholey v. Revenue Service, 90 U.S. 331 (1874).

Senate Report 94-938. (1976). 94th Congress, 2d Sess. 18.

Smith, A. (1913), An Inquiry into the Nature andCauses of the Wealth of Nations, New York: E.P.Dutton and Company.

Stamp Act of 1797, 1 Stat. 527.

Tax Reform Act of 1976, Public Law 94-455 §§ 2001-2009.

Tax Reform Act of 1986, Public Law 99-514.

Technical and Miscellaneous Revenue Act of 1988,Public Law 100-647.

The Internal Revenue Record and Customs Journal(1869), 9(15), 113.

U.S. Library of Congress, 6 November 1996, Thomas,Legislative Information on the Internet (availablefrom the Internet at http://thomas.loc.gov).

National Desk, Political Writer, 31 October 1996,National Desk.



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Wagner, Richard E. (1993), Federal Transfer Taxa-tion: A Study in Social Cost, Costa Mesa, Califor-nia: Center for the Study of Taxation.

War Revenue Act of 1898, 30 Stat. 448, 464.

War Revenue Reduction Act of 1901, 31 Stat. 956.

War Revenue Repeal Act of 1902, §7, 32 Stat. 92.

Zaritsky, H. and Ripy, T. (1984), Federal Estate, Gift,and Generation Skipping Taxes: A LegislativeHistory and Description of Current Law, (ReportNo. 84-156A), Washington, D.C.: CongressionalResearch Service.

SOURCE: "Inheritance and Wealth in America",editor; Robert K. Miller Jr., and Stephen J.McNamee, Plenum Press, NY, 1998.

NOTE: Views expressed in this paper are those ofthe authors and do not necessarily repesent theviews of the Treasury Department or the InternalRevenue Service.



HISTORY, PRESENT LAW, AND ANALYSIS OF THE FEDERAL WEALTH TRANSFER TAX SYSTEM

Scheduled for a Public Hearing Before the

SUBCOMMITTEE ON SELECT REVENUE MEASURES OF THE HOUSE COMMITTEE ON WAYS AND MEANS

on March 18, 2015

Prepared by the Staff

of the JOINT COMMITTEE ON TAXATION

March 16, 2015 JCX-52-15

Downloaded from https://www.jct.gov/publications.html?func=startdown&id=4744.



i

CONTENTS

Page

I. OVERVIEW .............................................................................................................................1

II. HISTORY OF THE U.S. WEALTH TRANSFER TAX SYSTEM ........................................4

A. In General ......................................................................................................................... 4B. Federal Taxes on Transfers at Death Before World War I .............................................. 4C. Estate Taxes from World War I Through World War II ................................................. 5D. Estate and Gift Taxes After World War II ....................................................................... 7E. Recent Legislation ......................................................................................................... 10F. Summary ........................................................................................................................ 11

III. DESCRIPTION OF PRESENT LAW ...................................................................................13

A. In General ....................................................................................................................... 13B. Common Features of the Estate, Gift and Generation-Skipping Transfer Taxes .......... 13C. The Estate Tax ............................................................................................................... 15D. The Gift Tax ................................................................................................................... 19E. The Generation-Skipping Transfer Tax ......................................................................... 21F. Income Tax Basis in Property Received ........................................................................ 22

IV. DATA AND ECONOMIC ISSUES RELATING TO ESTATE AND GIFT TAXATION ...........................................................................................................................24

A. Background Data ........................................................................................................... 24B. Economic Issues Related to Transfer Taxation ............................................................. 31

V. SELECTED PROPOSALS TO MODIFY THE TAXATION OF WEALTH TRANSFERS ...........................................................................................................................47

A. Overview ........................................................................................................................ 47B. Proposals to Repeal the Estate and Generation-Skipping Transfer Taxes ..................... 47C. Proposals to Reduce Exemption Amounts and Increase Tax Rates .............................. 47D. Proposals to Expand the Transfer Tax Base .................................................................. 48E. Proposal to Tax Built-in Gains at the Time of a Gift or upon Death ............................. 51



1

I. OVERVIEW

The Subcommittee on Select Revenue Measures of the House Committee on Ways and Means has scheduled a public hearing for March 18, 2015, on the burden of the estate tax on family businesses and farms. This document1 provides a history, description, and analysis of the Federal estate, gift, and generation-skipping transfer taxes (also referred to herein as the “wealth transfer taxes”), as well as a description of selected reform proposals. The overview presents data about wealth transfer taxes, a brief discussion of possible economic effects of the taxes, and a short summary of present-law rules.

Data about the Federal estate and gift tax

Revenues generated by the estate and gift tax are a small portion of overall Federal tax revenues. In fiscal year 2014, the IRS collected $19.3 billion in net estate and gift tax revenues. This amount represented 0.6 percent of total net Federal tax collections in fiscal year 2014. By comparison, the highest post-World War II share of total Federal revenues represented by the estate and gift tax was 2.6 percent in fiscal year 1972.2

Relatively few taxpayers are directly affected by the Federal estate and gift tax. In 2013, the most recent year for which final numbers are available, there were 2.6 million deaths in the United States, and 4,700 estate tax returns reporting some tax liability were filed. Thus, taxable estate tax returns represented approximately one-fifth of one percent of deaths in 2013. By comparison, in the mid-1970s taxable estate tax returns exceeded six percent of all deaths.

Economic ramifications of estate taxation

Although the Federal estate and gift tax accounts for a small share of total Federal revenues and directly affects a small percentage of taxpayers, it may have broad economic effects. First, the estate tax might affect aggregate capital formation, but there is not consensus among economists on this issue. Some economists believe that individuals’ attitudes toward leaving bequests have a significant effect on overall capital accumulation. The existence of an estate tax may influence these attitudes.

Second, the estate tax may affect individuals’ saving behavior. Because the estate tax increases the after-tax cost of leaving a bequest, the existence of the tax may discourage some individuals from saving for a bequest. On the other hand, individuals who want to give a bequest of a certain amount may increase their savings to account for the potential estate tax burden. There has been limited empirical analysis to determine the effect, if any, of the estate tax on individual saving.

1 This document may be cited as follows: Joint Committee on Taxation, History, Present Law, and

Analysis of the Federal Wealth Transfer Tax System (JCX-52-15), March 16, 2015. This document is also available on the Joint Committee on Taxation website at www.jct.gov.

2 Darien B. Jacobson, Brian G. Raub, and Barry W. Johnson, “The Estate Tax: Ninety Years and Counting,” in Internal Revenue Service, Statistics of Income Bulletin (Summer 2007), p. 125.



2

Third, the estate tax may have an impact on the amount of investment in small businesses. An estate tax might create cash flow difficulties for small businesses and thereby may cause small business owners to borrow money or to sell or otherwise liquidate businesses to pay estate tax liability. If small businesses are sold, there may be a shift toward less overall investment in small business. If small business owners borrow funds to pay the estate tax, they may reduce their investment in the businesses, and this reduced investment could have deleterious effects on the larger economy. Some observers argue, however, that the present estate tax imposes a limited burden on small business owners because the exemption level has risen to $5.43 million for estates of individuals dying in 2015 and because special rules allow installment payment of tax liability for estates consisting largely of closely-held business assets.

Another way in which the estate tax may affect the economy is through planning strategies to avoid the tax. To the extent that resources are shifted towards tax avoidance activities and away from more productive endeavors, the overall economy may be smaller as a result.

Current estate and gift tax rules

In general, a gift tax is imposed on certain lifetime transfers and an estate tax is imposed on certain transfers at death. A generation-skipping transfer tax generally is imposed on certain transfers, made either directly or in trust or using a similar arrangement, to a “skip person” (i.e., a beneficiary in a generation more than one generation younger than that of the transferor).

A unified credit is available with respect to taxable transfers by gift and at death.3 The unified credit offsets tax computed at the lowest estate and gift tax rates on a specified amount of transfers, referred to as the applicable exclusion amount, or exemption amount. The exemption amount was set at $5 million for 2010 and 2011 and is indexed for inflation for years after 2011. For 2015, the inflation-indexed estate and gift tax exemption amount is $5.43 million.4 An election is available under which any exemption that remains unused as of a decedent’s death generally is available for use by a surviving spouse (sometimes referred to as exemption portability). The top estate and gift tax rate is 40 percent.

Donors of lifetime gifts are provided an inflation-indexed annual exclusion of $14,000 per donee in 2015 for gifts of present interests in property during the taxable year. In addition, gifts and bequests to a spouse or to charity generally are not subject to gift tax or estate tax. A Federal estate tax deduction is allowed for certain death taxes paid to any foreign country, State or the District of Columbia.

Property acquired from a donor of a lifetime gift generally takes a carryover basis. “Carryover basis” means that the basis in the hands of the donee is the same as it was in the

3 Sec. 2010. Except as otherwise noted, all section references are to the Internal Revenue Code of 1986, as

amended (the “Code”).

4 The generation-skipping transfer tax exemption is equal to the applicable exemption in effect for estate tax purposes in any given year.



3

hands of the donor. Property acquired from a decedent’s estate generally takes a stepped-up basis. “Stepped-up basis” means that the basis of property acquired from a decedent’s estate generally is the fair market value on the date of the decedent’s death (or, if the alternate valuation date is elected, the earlier of six months after the decedent’s death or the date the property is sold or distributed by the estate).

Lawmakers and the Administration have offered numerous proposals to modify the present-law rules. Part V describes several recent proposals to: (1) repeal the estate and generation-skipping transfer taxes; (2) expand the taxation of wealth transfers by decreasing exemption amounts and increasing tax rates; (3) expand the transfer tax base; and (4) impose a new tax on the transfer of built-in gains at the time of a gift or upon a decedent’s death.



4

II. HISTORY OF THE U.S. WEALTH TRANSFER TAX SYSTEM

A. In General

Wealth transfer were first introduced into the U.S. Federal tax system in 1797. The present-law Federal wealth transfer tax system consists of three related components: a gift tax, an estate tax, and a generation-skipping transfer tax.

Over much of the past two decades, the estate and gift tax laws have remained in flux, creating uncertainty for taxpayers and their advisors. The Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”)5 gradually phased out the Federal estate and generation-skipping taxes from 2002 through 2009, principally through nearly annual increases in exemption amounts and reductions in applicable tax rates. EGTRRA then provided for a single-year repeal of the estate tax, only for decedents dying in 2010.

EGTRRA was scheduled to sunset at the end of 2010, with the estate and gift tax laws to revert to the structure that would have been in effect if EGTRRA had never been enacted (generally, a lower exemption amount and higher tax rates). Congress intervened in December 20106 and again in January 2013,7 ultimately establishing what is now a permanent estate and gift tax regime with a higher exemption amount ($5.43 million for 2015) that is indexed for inflation and a top rate of 40 percent.

B. Federal Taxes on Transfers at Death Before World War I

While States extensively used transfer taxes at death for various purposes, Federal taxes on transfers at death in the United States, for most of its history, were imposed primarily to finance wars or the threat of war. The first Federal tax on such transfers was imposed from 1797 until 1802 as a stamp tax on inventories of deceased persons, receipts of legacies, shares of personal estate, probates of wills, and letters of administration to pay for the development of strong naval forces felt necessary because of strained trade relations with France.8 After repeal of the stamp tax,9 there were no death-related taxes imposed by the Federal government until the Civil War, when the Federal government imposed an inheritance tax10 between 1862 and 1870.11

5 Pub. L. No. 107-16, Title V (June 7, 2001).

6 See the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, Pub. L. No. 111-312 (Dec. 17, 2010).

7 See the American Taxpayer Relief Act of 2012, Pub. L. No. 112-240 (Jan. 2, 2013).

8 Act of July 6, 1797, 1 Stat. 527.

9 Act of June 30, 1802, 2 Stat. 148.

10 Inheritance taxes typically are imposed on the recipient of a transfer from a decedent, whereas estate taxes are imposed on a decedent’s estate.

11 Act of July 1, 1862, 12 Stat. 432, 483; Act of July 15, 1870, 16 Stat. 256.



5

To finance the Spanish-American War, the Federal government imposed its first estate tax in 1898, 12 which remained in effect until its repeal in 1902.13

While prior death-related taxes were imposed primarily to finance warfare, in 1906 President Theodore Roosevelt proposed a progressive tax on all lifetime gifts and death-time bequests specifically for the purpose of limiting the amount that one individual could transfer to another and thereby to break up large concentrations of wealth. No legislation immediately resulted from the proposal.14

C. Estate Taxes from World War I Through World War II

Estate taxes to finance World War I

The commencement of World War I caused revenues from tariffs to fall. The Federal government in 191615 enacted a progressive estate tax on all property owned by the decedent at his or her death, certain lifetime transfers which were for inadequate consideration,16 transfers not intended to take effect until death,17 and transfers made in contemplation of death.

The 1916 estate tax, which in many respects was similar to the present-day estate tax, provided an exemption (in the form of a deduction) of $50,000 with rates from one percent on the first $50,000 of transferred assets to 10 percent on transferred assets in excess of $5 million. The next year, the revenue needs from the war resulted in increases in estate tax rates, with a top rate of 25 percent on transferred assets in excess of $10 million.18

Estate and gift taxes between World Wars I and II

Following the end of World War I, Congress debated whether an estate tax remained necessary. In the Revenue Act of 1918, the estate tax was retained, but estate tax rates on transfers under $1 million were reduced. At the same time, the tax was extended to life insurance proceeds in excess of $40,000 that were receivable by the estate or its executor and to property subject to a general power of appointment.19

12 War Revenue Act of 1898, 30 Stat. 448, 464 (July 4, 1898).

13 Act of April 12, 1902, 32 Stat. 96.

14 See quotation in Randolph E. Paul, Taxation in the United States, p. 88 (Boston 1954).

15 Act of September 8, 1916, 39 Stat. 756.

16 The present-law rule is now contained in section 2043.


18 Act of March 3, 1917, 39 Stat. 1000.

19 The present-law rules are now contained in sections 2041 and 2514.



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In 1924, the estate tax was changed by: (1) increasing the maximum rate to 40 percent; (2) broadening property subject to the tax to include jointly-owned property and property subject to a power retained by the decedent to alter, amend, or revoke the beneficial enjoyment of the property;20 and (3) allowing a credit for State death-related taxes of up to 25 percent of the Federal tax. In addition, the first gift tax was imposed, using the estate tax rate schedule.

In response to opposition to the estate and gift taxes, in 1926, the gift tax was repealed and estate tax rates were reduced to a maximum rate of 20 percent on transfers over $10 million. The exemption was increased from $50,000 to $100,000, and the credit for State death taxes was increased to 80 percent of the Federal tax.

With the Great Depression, revenues from other sources were declining, and the need for new revenues for government projects increased. As a result, in 1932 estate tax rates were increased, with a top rate of 45 percent on transfers over $10 million.21 The tax was made applicable to lifetime transfers in which the transferor retained a life estate or the power to control who benefits from the property or income from such property.22 The exemption was reduced to $50,000, and the Federal gift tax was reimposed (at 75 percent of the estate tax rates) for cumulative lifetime gifts in excess of $5,000 per year.

Estate and gift tax rates were further increased in 1934 with the highest marginal rates of 60 percent and 45 percent, respectively, applying to transfers in excess of $10 million. Estate and gift tax rates were increased again in 1935 with the highest marginal rates of 70 percent and 52.5 percent, respectively, applying to transfers in excess of $50 million.23 The exemption for both the estate and gift tax was modified in 1935 to $40,000 each.24

In 1940, a 10-percent surcharge was imposed on both income and estate and gift taxes, in light of the need for additional revenue necessitated by the military build-up just prior to World War II.25 Estate and gift tax rates were increased in 1941, with a top estate tax rate of 77 percent on transfers in excess of $50 million.26


21 Revenue Act of 1932, 47 Stat. 169 (June 6, 1932).

22 The present-law rule is now contained in section 2036(a).

23 Act of May 10, 1934, 48 Stat. 680.

24 Act of August 30, 1935, 49 Stat. 1014.

25 Revenue Act of 1940, 54 Stat. 516.

26 Act of September 20, 1941, 55 Stat. 687.



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Estate and gift taxes during World War II

In 1942, Congress again altered estate and gift taxes by: (1) setting the exemption from the estate tax at $60,000, setting the lifetime exemption from gift tax at $30,000,27 and providing an annual gift tax exclusion of $3,000; and (2) attempting to equate property in community property States with property owned in non-community property States by providing that in both community property States and non-community property States, each spouse would be taxed on the portion of jointly-owned or community property that each spouse contributed to that property’s acquisition cost.28

D. Estate and Gift Taxes After World War II

Post-World War II through 1975

The 1942 solution to the community property problem was viewed as complex. Congress provided a different solution in 1948 for equating community property States and non-community property States by providing the decedent or donor spouse a marital deduction for 50 percent of the property transferred to the other spouse, and, thus, effectively allowing both spouses to be taxed on one-half of the property’s value.29

In 1954, the estate tax treatment of life insurance was changed. Under a new rule, life insurance was subject to estate tax if the proceeds were paid to the decedent’s estate or executor or if the decedent retained “incidents of ownership” in the life insurance policy.30

The Small Business Tax Revision Act of 195831 provided for payment of Federal estate tax on certain closely-held businesses in installments over a 10-year period.32

Legislation from 1976 through 1980

In the Tax Reform Act of 1976 (“the 1976 Act”),33 Congress substantially revised estate and gift taxes. The 1976 Act unified the estate and gift taxes, such that a single graduated rate

27 The $60,000 death-time and the $30,000 lifetime exemptions remained at these levels until the Tax

Reform Act of 1976, when the estate and gift taxes were combined into a single unified tax that could be reduced by a unified credit which replaced the two exemptions.

28 Act of October 21, 1942, 56 Stat. 798.

29 Revenue Act of 1948, 62 Stat. 110.


31 Pub. L. No. 85-866 (Sept. 2, 1958).

32 The present-law rule has been subsequently modified; it is now contained in section 6166.

33 Pub. L. No. 94-455 (Oct. 4, 1976).



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schedule with a maximum rate of 70 percent applied to transfers during life and at death.34 As under present law, lifetime gifts were cumulative, with successive gifts potentially subject to higher rates, and transfers at death stacked on top of cumulative lifetime gifts for purposes of determining the applicable marginal rate on such transfers. In addition, the estate and gift tax exclusions were combined into a single “unified credit,” which at the time effectively exempted $175,625 of transfers from tax when fully phased in. The 1976 Act also changed the income tax rules applicable to the disposition of inherited assets from a rule that only taxed post-death appreciation (i.e., the basis in the hands of the heir was “stepped up” to its value on the date of the decedent’s death) to one that provided that the heir’s basis generally would be the same as it was in the hands of the decedent (i.e., the decedent’s basis in the property would “carry over” to be the basis to the heir). In addition, the 1976 Act provided a 100-percent marital deduction for the first $250,000 of property transferred to a surviving spouse.

Another significant change in 1976 was the imposition of a new transfer tax on generation-skipping transfers generally equal to the additional estate or gift tax that the decedent’s children would have paid if the property had passed directly to the children instead of skipping that generation and passing to, for example, a donor’s or decedent’s grandchildren.

The 1976 Act also included preferential rules for valuing family farms and small business held in estates. Specifically, the law provided that a farm or other real property used in a closely- held business could be valued at its current-use value rather than its highest and best use value, so long as the heirs continue to use the property for 15 years after the decedent’s death; and liberalized the provision that permits installment payments of estate tax on closely-held businesses by providing that only interest need be paid for the first four years after death and by lengthening the period of installment by an additional four years.35

In 1980, the estate tax carryover basis rules were retroactively repealed and replaced with the step-up basis rules.36


The Economic Recovery Tax Act of 1981 (the “1981 Act”)37 made a number of changes to the estate and gift tax rules, many of which either had the effect of reducing the number of

34 The present-law rules are now contained in sections 2001 and 2501.

35 The present-law “special-use valuation” rules are contained in section 2032A, and require heirs to continue to use the property for only 10 years after the decedent’s death. The 1976 Act also: (1) changed the treatment of gifts made in contemplation of death from a rebuttable presumption that gifts made within three years of death would be subject to estate tax to a rule that subjects certain gifts made within three years of death to the estate tax; (2) provided that each spouse was rebuttably presumed to have contributed equally to the acquisition cost of jointly-held property; (3) provided a limited deduction for bequests to children with no living parents (the so-called “orphan’s deduction”); and (4) provided statutory rules governing the disclaimer of gifts and bequests under which an unqualified, irrevocable refusal to accept any benefits from the gift or bequest generally within 9 months of the creation of the transferee’s interest is not treated as a gift by the disclaiming individual.

36 Crude Oil Windfall Profits Act of 1980, Pub. L. No. 96-223 (Apr. 2, 1980).

37 Pub. L. No. 97-34 (Aug. 13, 1981).



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taxable estates or reduced or eliminated taxes on transfers between spouses. For example, the 1981 Act increased the unified credit such that, when fully phased in in 1987, it effectively exempted the first $600,000 of transfers from the unified estate and gift tax, and reduced the top unified estate and gift tax rate from 70 percent to 50 percent over a four-year period (1982 through 1985). The 1981 Act provided an unlimited deduction for transfers to spouses and permitted such a deduction even when the donee spouse could not control the disposition of the property after that spouse’s death, so long as the spouse had an income interest in the property and the property was subject to that spouse’s estate and gift tax (referred to as “qualified terminable interest property”). Additionally, the 1981 Act) modified the special-use valuation rules by shortening to 10 years the period that heirs who inherit farms or other real property used in a closely held business were required to so use the property, and increased the maximum reduction in value of such property from $500,000 to $750,000; and further liberalized and simplified the rules that permit the installment payment of estate tax on closely-held businesses.38

The Deficit Reduction Act of 1984 made a number of additional modifications to the estate and gift tax rules.39


The Tax Reform Act of 198640 substantially revised the tax on generation-skipping transfers by applying a single rate of tax equal to the highest estate tax rate (i.e., 55 percent) to all generation-skipping transfers in excess of $1 million and by broadening the definition of a generation-skipping transfer to include direct transfers from a grandparent to a grandchild (i.e., direct skips).

The Omnibus Budget Reconciliation Act of 198741 modified the estate and gift tax by: (1) providing special rules under which so-called “estate freeze transactions” result in the inclusion in the decedent’s gross estate of the total value of property transferred; (2) providing a higher estate or gift tax rate on transfers in excess of $10 million to phase out the benefit of the graduated rates under 55 percent and the benefit of the unified credit; and (3) again delaying the scheduled reduction in the estate and gift tax rates from 55 percent to 50 percent for five years.

38 The present-law rule is now contained in section 2056. The 1981 Act also: (1) increased the annual gift

tax exemption from $3,000 per year per donee to $10,000 per year per donee; (2) changed the presumption that each spouse equally provided for the acquisition cost of jointly-held property to an irrebuttable presumption; (3) repealed the so-called “orphan’s deduction”; and (4) delayed the effective date of the generation-skipping transfer tax.

39 Pub. L. No. 98-369 (July 18, 1984). For example, the 1984 Act: (1) delayed for three years the scheduled reduction of the maximum estate and gift tax rates (such that the maximum rate remained at 55 percent until 1988); (2) eliminated the exclusion for interests in qualified retirement plans; (3) provided rules for the gift and income tax treatment of below-market rate loans; and (4) extended the rules that permit the installment payment of estate taxes on closely held businesses to certain holding companies.

40 Pub. L. No. 99-514 (Oct. 22, 1986). The present-law generation-skipping transfer tax rules added by the Tax Reform Act of 1986 are contained in sections 2601 through 2654.

41 Pub. L. No. 100-203 (Dec. 22, 1987).



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The Omnibus Budget Reconciliation Act of 199042 replaced the special rules for estate freeze transactions with a new set of rules that effectively subject to gift tax the full value of interests in property, unless retained interests in that property take certain specified forms.43

The maximum estate, gift, and generation-skipping transfer tax rate dropped to 50 percent after December 31, 1992, but the Omnibus Budget Reconciliation Act of 199344 restored the 55-percent top rate retroactively to January 1, 1993, and made that top rate permanent. The Taxpayer Relief Act of 199745 provided for gradual increases in the unified credit effective exemption amount from $625,000 in 1998 to $1 million in 2006 and thereafter. Under a conforming amendment to the five-percent surtax, the benefit of the graduated rates, but not the benefit of the unified credit, was phased out. A new exclusion for qualified conservation easements and a new deduction for interests in qualified family-owned businesses, in addition to other changes, also were enacted in 1997.

The Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”)46

EGTRRA signaled an attempt to reduce or eliminate the Federal estate and generation-skipping taxes by phasing out and ultimately repealing those taxes. EGTRRA phased out the estate and generation-skipping taxes through 2009 by gradually increasing the lifetime estate tax exemption to $3.5 million and reducing the top estate tax rate to 45 percent. In addition, the credit for State death taxes paid was reduced and, for estates of decedents dying after 2004, replaced by a deduction for such taxes. In 2010, the estate and generation-skipping taxes were to be repealed, though only for one year, after which the estate tax exemption would drop to $1 million with a top tax rate of 55 percent. The basis in assets transferred from a decedent who died in 2010 would no longer be stepped up; instead, a modified carryover basis regime was to take effect.

E. Recent Legislation

Reinstatement of the estate tax for 2010 and temporary extension of the modified estate and gift tax laws through 2012

Although EGTRRA had provided for temporary repeal of the estate and generation-skipping transfer taxes for deaths and transfers occurring in 2010, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the “2010 Act”), enacted December 17, 2010, retroactively reinstated the estate and generation-skipping transfer taxes effective January 1, 2010, and extended the new rules through 2012. The estate tax exemption was

42 Pub. L. No. 101-508 (Nov. 5, 2990).

43 The present-law rules are contained in sections 2701 through 2704.

44 Pub. L. No. 103-66 (Aug. 10, 1993).

45 Pub. L. No. 105-34 (Aug. 5, 1997).

46 Pub. L. No. 107-16 (June 7, 2001).



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increased to $5 million for 2010 and 2011 (and was indexed for inflation for years after 2011), and the top estate and gift tax rate was set at 35 percent. Beginning in 2011, the gift tax was reunified with the estate tax i.e., the gift tax exemption was raised to equal the estate tax exemption. The 2010 Act also repealed the EGTRRA modified carryover basis rules that were scheduled to be in effect for assets acquired from a decedent who died in 2010, such that the basis generally was stepped up to fair market value. Under the 2010 Act, any unused exemption of a decedent who died after 2010 generally was available for use by a surviving spouse (exemption portability).

To mitigate the effect of retroactively reinstating the estate tax, in the case of a decedent who died during 2010, the 2010 Act allowed the executor to elect to apply the Internal Revenue Code as if the reinstated estate tax and basis step-up rules described in the preceding paragraph had not been enacted. In other words, the executor could elect to have the law as originally enacted under EGTRRA apply for 2010 decedents, i.e., repeal of the estate tax, accompanied by application of the less generous modified carryover basis rules for assets acquired from a decedent.

Permanent extension of the estate and gift tax laws with an inflation-indexed exemption amount

The American Taxpayer Relief Act of 2012 made permanent the estate and gift tax laws that were in effect in 2012, but increased the top estate and gift tax rate to 40 percent. Thus, for all years after 2012, the estate and gift taxes are unified with an exemption amount that is indexed for inflation (from $5 million in 2011). For 2013, 2014, and 2015, the inflation-indexed exemption amounts are $5.25 million, $5.34 million, and $5.43 million, respectively.

The present-law estate and gift tax regime is discussed in greater detail in Part III, below.

F. Summary

Table 1 provides a summary of the annual gift tax exclusion, the exemption value of the unified credit, the threshold level of the highest statutory estate tax rate, and the highest statutory estate tax rate for selected years, 1977 through 2015.



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Table 1.–Estate and Gift Tax Rates and Exemption Amounts, 1977-2015

Year

Annual gift exclusion per

donee single/joint Exemption value of unified credit

Threshold of highest statutory

tax rate1

Highest statutory

tax rate(percent)

1977 $3,000/$6,000 $120,667 $5 million 70 1982 $10,000/$20,000 $225,000 $4 million 65 1983 $10,000/$20,000 $275,000 $3.5 million 60 1984 $10,000/$20,000 $325,000 $3 million 55 1985 $10,000/$20,000 $400,000 $3 million 55 1986 $10,000/$20,000 $500,000 $3 million 55 1987 $10,000/$20,000 $600,000 $3 million 55 2 1998 $10,000/$20,000 $625,000 $3 million 55 2 1999 $10,000/$20,000 $650,000 $3 million 55 2 2000 $10,000/$20,000 $675,000 $3 million 55 2 2002 $11,000/$22,000 $1 million $2.5 million 50 2003 $11,000/$22,000 $1 million $2 million 49 2004 $11,000/$22,000 $1.5 million $2 million 48 2005 $11,000/$22,000 $1.5 million $2 million 47 2006 $12,000/$24,000 $2 million $2 million 1 46 2007 $12,000/$24,000 $2 million $1.5 million 1 45 2009 $13,000/$26,000 $3.5 million $1.5 million 1 45 2010 $13,000/$26,000 $5 million $500,000 1 35 3 2012 $13,000/$26,000 $5.12 million $500,000 1 35 2013 $14,000/$28,000 $5.25 million $1 million 1 40 2014 $14,000/$28,000 $5.34 million $1 million 1 40 2015 $14,000/$28,000 $5.43 million $1 million 1 40

1 Because the exemption amount in later years equals or exceeds the threshold for the highest tax rate, transfers that equal or are in excess of the exemption amount generally are subject to a flat tax at the highest marginal rate. 2 From 1987 through 1997, the benefits of the graduated rate structure and unified credit were phased out at a 5-percent rate for estates between $10,000,000 and $21,040,000, creating an effective marginal tax rate of 60 percent for affected estates (with a $600,000 unified credit). The Taxpayer Relief Act of 1997 provided for gradual increases in the unified credit from $625,000 in 1998 to $1 million in 2006 and thereafter. A conforming amendment made to the 5-percent surtax continued to phase out the benefit of the graduated rates, but the benefit of the unified credit was no longer phased out. 3 As described in section II.E, above, for decedents dying in 2010, executors were permitted to elect not to have the estate subject to estate tax. Heirs who acquire assets from an electing decedent’s estate, however, took a modified carryover basis determined under then-section 1022 of the Code, instead of a stepped-up basis determined under section 1014 of the Code.



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III. DESCRIPTION OF PRESENT LAW

A. In General

A gift tax is imposed on certain lifetime transfers, and an estate tax is imposed on certain transfers at death. A generation-skipping transfer tax generally is imposed on transfers, either directly or in trust or similar arrangement, to a “skip person” (i.e., a beneficiary in a generation more than one generation younger than that of the transferor). Transfers subject to the generation-skipping transfer tax include direct skips, taxable terminations, and taxable distributions.

Income tax rules determine the recipient’s tax basis in property acquired from a decedent or by gift. Gifts and bequests generally are excluded from the recipient’s gross income.47

B. Common Features of the Estate, Gift and Generation-Skipping Transfer Taxes

Unified credit (exemption) and tax rates

Unified credit

A unified credit is available with respect to taxable transfers by gift and at death.48 The unified credit offsets tax computed at the lowest estate and gift tax rates on a specified amount of transfers, referred to as the applicable exclusion amount, or exemption amount. The exemption amount was set at $5 million for 2011 and is indexed for inflation for later years.49 For 2015, the inflation-indexed exemption amount is $5.43 million.50 Exemption used during life to offset taxable gifts reduces the amount of exemption that remains at death to offset the value of a decedent’s estate. An election is available under which exemption that is not used by a decedent may be used by the decedent’s surviving spouse (exemption portability).

Common tax rate table

A common tax-rate table with a top marginal tax rate of 40 percent is used to compute gift tax and estate tax. The 40-percent rate applies to transfers in excess of $1 million (to the extent not exempt). Because the exemption amount currently shields the first $5.43 million in gifts and bequests from tax, transfers in excess of the exemption amount generally are subject to tax at the highest marginal 40-percent rate.

47 Sec. 102.

48 Sec. 2010.

49 For 2011 and later years, the gift and estate taxes were reunified, meaning that the gift tax exemption amount was increased to equal the estate tax exemption amount.

50 For 2015, the $5.43 exemption amount results in a unified credit of $2,117,800, after applying the applicable rates set forth in section 2001(c).



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Generation-skipping transfer tax exemption and rate

The generation-skipping transfer tax is a separate tax that can apply in addition to either the gift tax or the estate tax. The tax rate and exemption amount for generation-skipping transfer tax purposes, however, are set by reference to the estate tax rules. Generation-skipping transfer tax is imposed using a flat rate equal to the highest estate tax rate (40 percent). Tax is imposed on cumulative generation-skipping transfers in excess of the generation-skipping transfer tax exemption amount in effect for the year of the transfer. The generation-skipping transfer tax exemption for a given year is equal to the estate tax exemption amount in effect for that year (currently $5.43 million).

Transfers between spouses

In general

A 100-percent marital deduction generally is permitted for the value of property transferred between spouses.51 In addition, transfers of “qualified terminable interest property” also are eligible for the marital deduction. Qualified terminable interest property is property: (1) that passes from the decedent, (2) in which the surviving spouse has a “qualifying income interest for life,” and (3) to which an election under these rules applies. A qualifying income interest for life exists if: (1) the surviving spouse is entitled to all the income from the property (payable annually or at more frequent intervals) or has the right to use the property during the spouse’s life, and (2) no person has the power to appoint any part of the property to any person other than the surviving spouse.

Transfers to surviving spouses who are not U.S. citizens

A marital deduction generally is denied for property passing to a surviving spouse who is not a citizen of the United States. A marital deduction is permitted, however, for property passing to a qualified domestic trust of which the noncitizen surviving spouse is a beneficiary. A qualified domestic trust is a trust that has as its trustee at least one U.S. citizen or U.S. corporation. No corpus may be distributed from a qualified domestic trust unless the U.S. trustee has the right to withhold any estate tax imposed on the distribution.

Tax is imposed on (1) any distribution from a qualified domestic trust before the date of the death of the noncitizen surviving spouse and (2) the value of the property remaining in a qualified domestic trust on the date of death of the noncitizen surviving spouse. The tax is computed as an additional estate tax on the estate of the first spouse to die.

Transfers to charity

Contributions to charitable and certain other organizations may be deducted from the value of a gift or from the value of the assets in an estate for Federal gift or estate tax purposes.52

51 Secs. 2056 and 2523.

52 Secs. 2055 and 2522.



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The effect of the deduction generally is to remove the full fair market value of assets transferred to charity from the gift or estate tax base; unlike the income tax charitable deduction, there are no percentage limits on the deductible amount. For estate tax purposes, the charitable deduction is limited to the value of the transferred property that is required to be included in the gross estate.53 A charitable contribution of a partial interest in property, such as a remainder or future interest, generally is not deductible for gift or estate tax purposes.54

C. The Estate Tax

Overview

The Code imposes a tax on the transfer of the taxable estate of a decedent who is a citizen or resident of the United States.55 The taxable estate is determined by deducting from the value of the decedent’s gross estate any deductions provided for in the Code. After applying tax rates to determine a tentative amount of estate tax, certain credits are subtracted to determine estate tax liability.56

Because the estate tax shares a common unified credit (exemption) and tax rate table with the gift tax, the exemption amounts and tax rates are described together in Part III.B, above, along with certain other common features of these taxes.

Gross estate

A decedent’s gross estate includes, to the extent provided for in other sections of the Code, the date-of-death value of all of a decedent’s property, real or personal, tangible or intangible, wherever situated.57 In general, the value of property for this purpose is the fair market value of the property as of the date of the decedent’s death, although an executor may

53 Sec. 2055(d).

54 Secs. 2055(e)(2) and 2522(c)(2).

55 Sec. 2001(a).

56 More mechanically, the taxable estate is combined with the value of adjusted taxable gifts made during the decedent’s life (generally, post-1976 gifts), before applying tax rates to determine a tentative total amount of tax. The portion of the tentative tax attributable to lifetime gifts is then subtracted from the total tentative tax to determine the gross estate tax, i.e., the amount of estate tax before considering available credits. Credits are then subtracted to determine the estate tax liability.

This method of computation was designed to ensure that a taxpayer only gets one run up through the rate brackets for all lifetime gifts and transfers at death, at a time when the thresholds for applying the higher marginal rates exceeded the exemption amount. However, the higher ($5.43 million) present-law exemption amount effectively renders the lower rate brackets irrelevant, because the top marginal rate bracket applies to all transfers in excess of $1 million. In other words, all transfers that are not exempt by reason of the $5.43 million exemption amount are taxed at the highest marginal rate of 40 percent.

57 Sec. 2031(a).



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elect to value certain property as of the date that is six months after the decedent’s death (the alternate valuation date).58

The gross estate includes not only property directly owned by the decedent, but also other property in which the decedent had a beneficial interest at the time of his or her death.59 The gross estate also includes certain transfers made by the decedent prior to his or her death, including: (1) certain gifts made within three years prior to the decedent’s death;60 (2) certain transfers of property in which the decedent retained a life estate;61 (3) certain transfers taking effect at death;62 and (4) revocable transfers.63 In addition, the gross estate also includes property with respect to which the decedent had, at the time of death, a general power of appointment (generally, the right to determine who will have beneficial ownership).64 The value of a life insurance policy on the decedent’s life is included in the gross estate if the proceeds are payable to the decedent’s estate or the decedent had incidents of ownership with respect to the policy at the time of his or her death. 65

Deductions from the gross estate

A decedent’s taxable estate is determined by subtracting from the value of the gross estate any deductions provided for in the Code.

Marital and charitable transfers

As described in Part III.B, above, transfers to a surviving spouse or to charity generally are deductible for estate tax purposes. The effect of the marital and charitable deductions generally is to remove assets transferred to a surviving spouse or to charity from the estate tax base.

State death taxes

An estate tax deduction is permitted for death taxes (e.g., any estate, inheritance, legacy, or succession taxes) actually paid to any State or the District of Columbia, in respect of property included in the gross estate of the decedent.66 Such State taxes must have been paid and claimed

58 Sec. 2032.

59 Sec. 2033.

60 Sec. 2035.

61 Sec. 2036.

62 Sec. 2037.

63 Sec. 2038.

64 Sec. 2041.

65 Sec. 2042.

66 Sec. 2058.



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before the later of: (1) four years after the filing of the estate tax return; or (2) (a) 60 days after a decision of the U.S. Tax Court determining the estate tax liability becomes final, (b) the expiration of the period of extension to pay estate taxes over time under section 6166, or (c) the expiration of the period of limitations in which to file a claim for refund or 60 days after a decision of a court in which such refund suit has become final.

Other deductions

A deduction is available for funeral expenses, estate administration expenses, and claims against the estate, including certain taxes.67 A deduction also is available for uninsured casualty and theft losses incurred during the settlement of the estate.68

Credits against tax

After accounting for allowable deductions, a gross amount of estate tax is computed. Estate tax liability is then determined by subtracting allowable credits from the gross estate tax.

Unified credit

The most significant credit allowed for estate tax purposes is the unified credit, which is discussed in greater detail above.69 For 2015, the value of the unified credit is $2,117,800, which has the effect of exempting $5.43 million in transfers from tax. The unified credit available at death is reduced by the amount of unified credit used to offset gift tax on gifts made during the decedent’s life.

Other credits

Estate tax credits also are allowed for: (1) gift tax paid on certain pre-1977 gifts (before the estate and gift tax computations were integrated);70 (2) estate tax paid on certain prior transfers (to limit the estate tax burden when estate tax is imposed on transfers of the same property in two estates by reason of deaths in rapid succession);71 and (3) certain foreign death taxes paid (generally, where the property is situated in a foreign country but included in the decedent’s U.S. gross estate).72

67 Sec. 2053.

68 Sec. 2054.

69 Sec. 2010.

70 Sec. 2012.

71 Sec. 2013.

72 Sec. 2014. In certain cases, an election may be made to deduct foreign death taxes. See section 2053(d).



18

Provisions affecting small and family-owned businesses and farms

Special-use valuation

An executor can elect to value for estate tax purposes certain “qualified real property” used in farming or another qualifying closely-held trade or business at its current-use value, rather than its fair market value.73 The maximum reduction in value for such real property is $750,000 (adjusted for inflation occurring after 1997; the inflation-adjusted amount for 2015 is $1,100,000). In general, real property generally qualifies for special-use valuation only if (1) at least 50 percent of the adjusted value of the decedent’s gross estate (including both real and personal property) consists of a farm or closely-held business property in the decedent’s estate and (2) at least 25 percent of the adjusted value of the gross estate consists of farm or closely held business real property. In addition, the property must be used in a qualified use (e.g., farming) by the decedent or a member of the decedent’s family for five of the eight years before the decedent’s death.

If, after a special-use valuation election is made, the heir who acquired the real property ceases to use it in its qualified use within 10 years of the decedent’s death, an additional estate tax is imposed to recapture the entire estate-tax benefit of the special-use valuation.74

Installment payment of estate tax for closely held businesses

Under present law, the estate tax generally is due within nine months of a decedent’s death. However, an executor generally may elect to pay estate tax attributable to an interest in a

73 Sec. 2032A.

74 Prior to 2004, an estate also was permitted to deduct the adjusted value of a qualified family-owned business interest of the decedent, up to $675,000. Sec. 2057. A qualified family-owned business interest generally was defined as any interest in a trade or business (regardless of the form in which it is held) with a principal place of business in the United States if the decedent’s family owns at least 50 percent of the trade or business, two families own 70 percent, or three families own 90 percent, as long as the decedent’s family owns at least 30 percent of the trade or business. To qualify for the exclusion, the decedent (or a member of the decedent’s family) must have owned and materially participated in the trade or business for at least five of the eight years preceding the decedent’s date of death. In addition, at least one qualified heir (or member of the qualified heir’s family) was required to have materially participated in the trade or business for at least 10 years following the decedent’s death. The qualified family-owned business rules provided a graduated recapture based on the number of years after the decedent’s death within which a disqualifying event occurred.

The qualified family-owned business deduction and the unified credit effective exemption amount were coordinated. If the maximum deduction amount of $675,000 is elected, then the unified credit effective exemption amount is $625,000, for a total of $1.3 million. If the qualified family-owned business deduction is less than $675,000, then the unified credit effective exemption amount is equal to $625,000, increased by the difference between $675,000 and the amount of the qualified family-owned business deduction. However, the unified credit effective exemption amount cannot be increased above such amount in effect for the taxable year. Because of the coordination between the qualified family-owned business deduction and the unified credit effective exemption amount, the qualified family-owned business deduction did not provide a benefit in any year in which the applicable exclusion amount exceeded $1.3 million.



19

closely held business in two or more installments (but no more than 10).75 An estate is eligible for payment of estate tax in installments if the value of the decedent’s interest in a closely held business exceeds 35 percent of the decedent’s adjusted gross estate (i.e., the gross estate less certain deductions). If the election is made, the estate may defer payment of principal and pay only interest for the first five years, followed by up to 10 annual installments of principal and interest. This provision effectively extends the time for paying estate tax by 14 years from the original due date of the estate tax. A special two-percent interest rate applies to the amount of deferred estate tax attributable to the first $1 million (adjusted annually for inflation occurring after 1998; the inflation-adjusted amount for 2015 is $1,470,000) in taxable value of a closely held business. The interest rate applicable to the amount of estate tax attributable to the taxable value of the closely held business in excess of $1 million (adjusted for inflation) is equal to 45 percent of the rate applicable to underpayments of tax under section 6621 of the Code (i.e., 45 percent of the Federal short-term rate plus three percentage points).76 Interest paid on deferred estate taxes is not deductible for estate or income tax purposes.

D. The Gift Tax

Overview

The Code imposes a tax for each calendar year on the transfer of property by gift during such year by any individual, whether a resident or nonresident of the United States.77 The amount of taxable gifts for a calendar year is determined by subtracting from the total amount of gifts made during the year: (1) the gift tax annual exclusion (described below); and (2) allowable deductions.

Gift tax for the current taxable year is determined by: (1) computing a tentative tax on the combined amount of all taxable gifts for the current and all prior calendar years using the common gift tax and estate tax rate table; (2) computing a tentative tax only on all prior-year gifts; (3) subtracting the tentative tax on prior-year gifts from the tentative tax computed for all years to arrive at the portion of the total tentative tax attributable to current-year gifts; and, finally, (4) subtracting the amount of unified credit not consumed by prior-year gifts.

Because the gift tax shares a common unified credit (exemption) and tax rate table with the estate tax, the exemption amounts and tax rates are described together in Part III.B, above, along with certain other common features of these taxes.

Transfers by gift

The gift tax applies to a transfer by gift regardless of whether: (1) the transfer is made outright or in trust; (2) the gift is direct or indirect; or (3) the property is real or personal, tangible

75 Sec. 6166.

76 The interest rate on this portion adjusts with the Federal short-term rate.

77 Sec. 2501(a).



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or intangible.78 For gift tax purposes, the value of a gift of property is the fair market value of the property at the time of the gift.79 Where property is transferred for less than full consideration, the amount by which the value of the property exceeds the value of the consideration is considered a gift and is included in computing the total amount of a taxpayer’s gifts for a calendar year.80

For a gift to occur, a donor generally must relinquish dominion and control over donated property. For example, if a taxpayer transfers assets to a trust established for the benefit of his or her children, but retains the right to revoke the trust, the taxpayer may not have made a completed gift, because the taxpayer has retained dominion and control over the transferred assets. A completed gift made in trust, on the other hand, often is treated as a gift to the trust beneficiaries.

By reason of statute, certain transfers are not treated as transfers by gift for gift tax purposes. These include, for example, certain transfers for educational and medical purposes81 and transfers to section 527 political organizations.82

Taxable gifts

As stated above, the amount of a taxpayer’s taxable gifts for the year is determined by subtracting from the total amount of the taxpayer’s gifts for the year the gift tax annual exclusion and any available deductions.

Gift tax annual exclusion

Under present law, donors of lifetime gifts are provided an annual exclusion of $14,000 per donee in 2015 (indexed for inflation from the 1997 annual exclusion amount of $10,000) for gifts of present interests in property during the taxable year.83 If the non-donor spouse consents to split the gift with the donor spouse, then the annual exclusion is $28,000 per donee in 2015. In general, unlimited transfers between spouses are permitted without imposition of a gift tax. Special rules apply to the contributions to a qualified tuition program (“529 Plan”) including an election to treat a contribution that exceeds the annual exclusion as a contribution made ratably over a five-year period beginning with the year of the contribution.84

78 Sec. 2511(a).

79 Sec. 2512(a).

80 Sec. 2512(b).

81 Sec. 2503(e).

82 Sec. 2501(a)(4).

83 Sec. 2503(b).

84 Sec. 529(c)(2).



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Marital and charitable deductions

As described in Part III.B, above, transfers to a surviving spouse or to charity generally are deductible for gift tax purposes. The effect of the marital and charitable deductions generally is to remove assets transferred to a surviving spouse or to charity from the gift tax base.

E. The Generation-Skipping Transfer Tax

A generation-skipping transfer tax generally is imposed (in addition to the gift tax or the estate tax) on transfers, either directly or in trust or similar arrangement, to a “skip person” (i.e., a beneficiary in a generation more than one generation below that of the transferor). Transfers subject to the generation-skipping transfer tax include direct skips, taxable terminations, and taxable distributions.

Exemption and tax rate

An exemption generally equal to the estate tax exemption amount ($5.43 million for 2015) is provided for each person making generation-skipping transfers. The exemption may be allocated by a transferor (or his or her executor) to transferred property, and in some cases is automatically allocated. The allocation of generation-skipping transfer tax exemption effectively reduces the tax rate on a generation-skipping transfer.

The tax rate on generation-skipping transfers is a flat rate of tax equal to the maximum estate and gift tax rate (40 percent) multiplied by the “inclusion ratio.” The inclusion ratio with respect to any property transferred indicates the amount of “generation-skipping transfer tax exemption” allocated to a trust (or to property transferred in a direct skip) relative to the total value of property transferred.85 If, for example, a taxpayer transfers $5 million in property to a trust and allocates $5 million of exemption to the transfer, the inclusion ratio is zero, and the applicable tax rate on any subsequent generation-skipping transfers from the trust is zero percent (40 percent multiplied by the inclusion ratio of zero). If, however, the taxpayer allocated only $2.5 million of exemption to the transfer, the inclusion ratio is 0.5, and the applicable tax rate on any subsequent generation-skipping transfers from the trust is 20 percent (40 percent multiplied by the inclusion ratio of 0.5). If the taxpayer allocates no exemption to the transfer, the inclusion ratio is one, and the applicable tax rate on any subsequent generation-skipping transfers from the trust is 40 percent (40 percent multiplied by the inclusion ratio of one).

Generation-skipping transfers

Generation-skipping transfer tax generally is imposed at the time of a generation-skipping transfer a direct skip, a taxable termination, or a taxable distribution.

A direct skip is any transfer subject to estate or gift tax of an interest in property to a skip person. A skip person may be a natural person or certain trusts. All persons assigned to the

85 The inclusion ratio is one minus the applicable fraction. The applicable fraction is the amount of

exemption allocated to a trust (or to a direct skip) divided by the value of assets transferred.



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second or more remote generation below the transferor are skip persons (e.g., grandchildren and great-grandchildren). Trusts are skip persons if (1) all interests in the trust are held by skip persons, or (2) no person holds an interest in the trust and at no time after the transfer may a distribution (including distributions and terminations) be made to a non-skip person.

A taxable termination is a termination (by death, lapse of time, release of power, or otherwise) of an interest in property held in trust unless, immediately after such termination, a non-skip person has an interest in the property, or unless at no time after the termination may a distribution (including a distribution upon termination) be made from the trust to a skip person.

A taxable distribution is a distribution from a trust to a skip person (other than a taxable termination or direct skip). If a transferor allocates generation-skipping transfer tax exemption to a trust prior to the taxable distribution, generation-skipping transfer tax may be avoided.

F. Income Tax Basis in Property Received

In general

Gain or loss, if any, on the disposition of property is measured by the taxpayer’s amount realized (i.e., gross proceeds received) on the disposition, less the taxpayer’s basis in such property. Basis generally represents a taxpayer’s investment in property with certain adjustments required after acquisition. For example, basis is increased by the cost of capital improvements made to the property and decreased by depreciation deductions taken with respect to the property.

A gift or bequest of appreciated (or loss) property is not an income tax realization event for the transferor. The Code provides special rules for determining a recipient’s basis in assets received by lifetime gift or from a decedent.

Basis in property received by lifetime gift

Under present law, property received from a donor of a lifetime gift generally takes a carryover basis. “Carryover basis” means that the basis in the hands of the donee is the same as it was in the hands of the donor. The basis of property transferred by lifetime gift also is increased, but not above fair market value, by any gift tax paid by the donor. The basis of a lifetime gift, however, generally cannot exceed the property’s fair market value on the date of the gift. If a donor’s basis in property is greater than the fair market value of the property on the date of the gift, then, for purposes of determining loss on a subsequent sale of the property, the donee’s basis is the property’s fair market value on the date of the gift.

Basis in property acquired from a decedent

Property acquired from a decedent’s estate generally takes a stepped-up basis. “Stepped-up basis” means that the basis of property acquired from a decedent’s estate generally is the fair market value on the date of the decedent’s death (or, if the alternate valuation date is elected, the earlier of six months after the decedent’s death or the date the property is sold or distributed by the estate). Providing a fair market value basis eliminates the recognition of income on any



23

appreciation of the property that occurred prior to the decedent’s death and eliminates the tax benefit from any unrealized loss.

In community property states, a surviving spouse’s one-half share of community property held by the decedent and the surviving spouse (under the community property laws of any State, U.S. possession, or foreign country) generally is treated as having passed from the decedent and, thus, is eligible for stepped-up basis. Thus, both the decedent’s one-half share and the surviving spouse’s one-half share are stepped up to fair market value. This rule applies if at least one-half of the whole of the community interest is includible in the decedent’s gross estate.

Stepped-up basis treatment generally is denied to certain interests in foreign entities. Stock in a passive foreign investment company (including those for which a mark-to-market election has been made) generally takes a carryover basis, except that stock of a passive foreign investment company for which a decedent shareholder had made a qualified electing fund election is allowed a stepped-up basis. Stock owned by a decedent in a domestic international sales corporation (or former domestic international sales corporation) takes a stepped-up basis reduced by the amount (if any) which would have been included in gross income under section 995(c) as a dividend if the decedent had lived and sold the stock at its fair market value on the estate tax valuation date (i.e., generally the date of the decedent’s death unless an alternate valuation date is elected).



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IV. DATA AND ECONOMIC ISSUES RELATING TO ESTATE AND GIFT TAXATION

A. Background Data

Estates subject to the estate tax

Table 2 details the percentage of decedents subject to the estate tax for selected years since 1935. The percentage of decedents liable for the estate tax grew throughout the postwar era reaching a peak in the mid-1970s. The substantial revision to the estate tax in the mid-1970s and subsequent further modifications in 1981 reduced the percentage of decedents liable for the estate tax to less than one percent in the late 1980s. The percentage of decedents liable for the estate tax increased from year to year from 1988 through 2000. The increases in the unified credit enacted in 2001 and 2010 (and made permanent in 2013) reduced substantially the percentage of decedents’ estates liable for the estate tax.



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Table 2.–Number of Taxable Estate Tax Returns Filed as a Percentage of Deaths, Selected Years, 1935-2013

Taxable estate tax

returns filed1

Year Deaths Number Percent of deaths 1935 1,172,245 8,655 0.74 1940 1,237,186 12,907 1.04 1945 1,239,713 13,869 1.12 1950 1,304,343 17,411 1.33 1955 1,379,826 25,143 1.82 1961 1,548,665 45,439 2.93 1966 1,727,240 67,404 2 3.90 1970 1,796,940 93,424 2 5.20 1973 1,867,689 120,761 2 6.47 1977 1,819,107 139,115 2 7.65 1982 1,897,820 41,620 2,3 2.19 1984 1,968,128 31,507 2,3 1.60 1986 2,105,361 23,731 1.13 1988 2,167,999 18,948 0.87 1990 4 2,148,463 23,104 1.08 1992 4 2,175,613 27,397 1.26 1994 4 2,278,994 31,918 1.40 1996 4 2,314,690 37,711 1.63 1998 4 2,337,256 47,475 2.03 2000 4 2,403,351 52,000 2.16 2002 4 2,443,387 45,018 1.84 2004 4 2,397,615 31,329 1.31 2006 4 2,426,264 22,798 0.94 2008 4 2,471,984 17,144 0.69 2010 4 2,468,435 6,711 0.27 2011 4 2,515,458 1,480 0.06 2012 4 2,543,279 3,738 0.15 2013 4 2,596,993 4,687 0.18

1 Estate tax returns need not be filed in the year of the decedent’s death. 2 Not strictly comparable with pre-1966 data. For later years the estate tax after credits was the basis for determining taxable returns. For prior years, the basis was the estate tax before credits. 3 Although the filing requirement was for gross estates in excess of $225,000 for 1982 deaths, $275,000 for 1983 deaths, and $325,000 for 1984 deaths, the data are limited to gross estates of $300,000 or more. 4 Taxable estate data from 1989-2013 are from Internal Revenue Service, Statistics of Income. Sources: Joseph A. Pechman, Federal Tax Policy (Washington: Brookings Institution), 1987; Internal Revenue Service, Statistics of Income; and U.S. National Center for Health Statistics.

The increasing percentage of decedents liable for estate tax in the period from 1940 through the mid-1970s and the similar increasing percentage from 1989 to 2000 are the result of the interaction of three factors: a fixed nominal exemption; the effect of price inflation on asset



26

values; and real economic growth (and, correspondingly, real wealth growth). Prior to 2011, the amount of wealth exempt from the Federal estate tax had always been expressed at a fixed nominal value. If the general price level in the economy rises from one year to the next and asset values rise to reflect this inflation, the “nominal” value of each individual’s wealth will increase. With a fixed nominal exemption, annual increases in the price level will imply that more individuals will have a nominal wealth that exceeds the tax threshold. Alternatively stated, inflation diminishes the real, inflation-adjusted, value of wealth that is exempted by a nominal exemption. Thus, even if no one individual’s real wealth increased, more individuals would be subject to the estate tax. This interaction between inflation and a fixed nominal exemption largely explains the pattern in Table 2.86 The fixed nominal exemption was increased effective for 1977, again between 1982 and 1987, and a series of increases was enacted in 2001, 2010, and 2013. Prior to 1977 and from 1987 through 2001, the exemption was little changed while the economy experienced general price inflation.

However, even now that the exemption is modified annually to reflect general price inflation, one would still expect to see the percentage of decedents liable for estate tax rise because of the third factor, real growth. If the economy is experiencing real growth per capita, it must be accumulating capital.87 Accumulated capital is the tax base of the estate tax. Thus, real growth can lead to more individuals having real wealth above any given fixed real exempt amount.88

86 The 1988 percentage of decedents liable for estate tax of 0.87 may overstate the nadir achieved by the

increase in the unified credit to an exemption equivalent amount of $600,000. This is because the 1981 legislation also increased the marital exemption to an unlimited exemption. An increase in the marital exemption would be expected to reduce the percentage of decedents liable for the estate tax, both permanently and during a temporary period following the increase. The permanent effect results from some married couples having neither spouse liable for estate tax. The temporary reduction in the percentage of decedents liable for estate tax arises as follows. A married couple may have sufficient assets to be subject to the estate tax. During the transition period in which husbands and wives first take advantage of the unlimited marital exemption, the number of decedents liable for estate tax falls as the first spouse to die takes advantage of the expanded marital deduction, despite the fact that the surviving spouse subsequently dies with a taxable estate. In the long run, the number of new couples utilizing the unlimited marital deduction may be expected to approximately equal the number of surviving spouses becoming taxable after their decedent spouse had claimed the unlimited marital deduction.

87 The analysis of the text assumes that the capital accumulated is physical or business intangible capital. Real per capita GNP could grow if individuals accumulated more knowledge and skills, or what economists call “human capital.” Accumulation of human capital unaccompanied by the accumulation of physical or business intangible capital would not necessarily lead to increasing numbers of decedents becoming liable for estate tax.

88 This analysis assumes that the capital accumulation is held broadly. If the growth in the capital stock were all due to a declining number of individuals doing the accumulating, then the distribution of wealth would become less equal and real growth could be accompanied by a declining percentage of decedents being liable for estate tax. Alternatively, if all of the capital accumulation accrued to individuals far below the exemption threshold, then even though the distribution of wealth becomes more equal, real growth could also be accompanied by a declining percentage of decedents being liable for estate tax.



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Revenues from the estate, gift, and generation-skipping taxes

Table 3 provides summary statistics of the estate and gift tax for selected years from 1940 through 2014. Total estate and gift receipts include taxes paid for estate, gift, and generation-skipping transfer taxes as well as payments made as the result of IRS audits.

Between 1990 and 1999, transfer tax receipts averaged double-digit rates of growth. There are three possible reasons for the rapid growth in these receipts. First, because neither the amount of wealth that was exempt from transfer taxes nor the tax rates were indexed for inflation, as explained above, an increasing number of persons were subject to estate and gift taxes. Second, the substantial increase in value in the stock market during the decade of the 1990s increased the value of estates that would have already been taxable, and increased the number of taxable estates. For example, the Dow Jones Industrial Average ended 1989 at approximately 2,750 and ended 1999 at approximately 11,000. A substantial portion of the wealth in taxable estates consists of publicly traded stocks. Because the value of this component of wealth more than tripled during the decade, one would expect brisk growth in estate tax receipts from this alone. Finally, the unlimited marital deduction included in the 1981 Act delayed the payment of estate tax, in most cases, until the surviving spouse died. As a result, married taxpayers who died during the 1980s were able to reduce estate tax liability by claiming an unlimited marital deduction for transfers to a surviving spouse. This resulted in an increase in estate tax receipts during the decade of the 1990s, when a significant number of such surviving spouses died and paid estate tax on assets acquired from an earlier-deceased spouse.89

89 See David Joulfaian, “The Federal Estate and Gift Tax: Description, Profile of Taxpayers, and Economic

Consequences,” U.S. Department of the Treasury, OTA Paper 80, December 1998. Table 19 of that publication displays the life expectancy of a surviving spouse and shows that 55 percent of spouses die within 10 years of the first-to-die spouse.



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Table 3.–Revenue from the Estate, Gift, and Generation-Skipping Transfer Taxes, Selected Fiscal Years, 1940-2014

Year Revenues

($ Millions) Percentage of total

Federal receipts

1940

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

353

637

698

924

1,606

2,716

3,644

4,611

6,389

6,422

11,500

14,763

29,010

24,764

27,877

26,044

28,844

23,482

18,885

7,399

13.973

18,912

19,300

5.4

1.4

1.8

1.4

1.7

2.3

1.9

1.7

1.2

0.9

1.1

1.1

1.4

1.1

1.2

1.0

1.1

1.1

0.9

0.3

0.6

0.7

0.6

Sources: Budget of the United States Government, Fiscal Year 2016: Historical Tables, Tables 2.1 and 2.5, accessed at www.whitehouse.gov/omb/budget/Historicals.



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On the other hand, the 1997, 2001, 2010 and 2013 Acts included provisions that would be expected to reduce the number of estates subject to the estate tax. As explained above, the exemption equivalent amount provided by the unified credit increased to $3.5 million in 2009 and $5 million in 2010.90 The $5 million figure is indexed for inflation for inflation for years after 2011 and stands at $5.43 million for 2015. The average rate of increase in the exemption amount exceeds the rate of inflation. As explained above, increases in the real value of the unified credit generally would be expected to reduce the number of estates subject to tax. The 1997 Act also provided an additional exemption for certain qualified family-owned business interests and a partial exclusion from the estate tax of the value of land subject to certain conservation easements. While the exemption for qualified family-owned business is no longer operable, these changes reduced the number of estates that would be expected to be subject to tax between 1997 and the present.

Table 4 shows the Joint Committee on Taxation staff present-law estimate of revenues from the estate, gift, and generation-skipping transfer taxes resulting from transfers in calendar years 2015-2024. These estimates are based on the December 2014 baseline forecast for estate, gift, and generation-skipping transfer taxes supplied by the Congressional Budget Office. Table 4 also reports the Joint Committee on Taxation staff estimates of annual taxable estates and calculations of the percentage of all deaths that taxable estates will represent.

90 The 2010 Act provided that in the case of a decedent dying during 2010, the executor could elect to

apply the law as originally enacted under EGTRRA (i.e., repeal of the estate tax and the application of the modified carryover basis rules for assets acquired from a decedent).



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Table 4.–Projections of Taxable Estates and Receipts from Estate, Gift, and Generation-Skipping Transfer Taxes, 2015-2024

Year Exemption value of unified credit

Number of taxable estates Percent of deaths

Receipts

($ billions)

2015 $5,430,000 5,400 0.2 21.5

2016 $5,490,000 5,400 0.2 21.9

2017 $5,600,000 5,400 0.2 22.5

2018 $5,730,000 5,400 0.2 23.3

2019 $5,860,000 5,400 0.2 24.2

2020 $6,000,000 5,500 0.2 25.0

2021 $6,140,000 5,500 0.2 26.0

2022 $6,290,000 5,500 0.2 26.8

2023 $6,450,000 5,500 0.2 27.6

2024 $6,600,000 5,500 0.2 28.4

Source: Joint Committee on Taxation staff estimates and calculations based on U.S. Census Bureau estimates of deaths from National Population Projections: Downloadable Files, Table 3, available at www.census.gov/population/projections/data/national/2014/downloadablefiles.html.



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B. Economic Issues Related to Transfer Taxation

Taxes on income versus taxes on wealth

Income taxes, payroll taxes, and excise and other consumption taxes generally tax economic activity as it occurs. Income and consumption represent ongoing, current economic activity by the taxpayer.91 Estate and gift taxes are levied on the transfer of accumulated wealth. Accumulated wealth does not result from any ongoing, current economic activity.92 Wealth depends upon previous economic activity either by the current wealth holder or other individuals. For example, current wealth can result from accumulated saving from income or from bequests received.

Taxes on wealth are not directly comparable to taxes on income. Because wealth is the accumulation of flows of saving over a period of years, taxes on wealth are not directly comparable to taxes on income or consumption which may represent only current, rather than accumulated, economic activity. For example, assume that a taxpayer receives wage income of $10,000 per year, saves all of this income, and the savings earn an annual return of five percent. At the end of five years, the accumulated value of the taxpayer’s investments would be $58,019. Assume that the wealth is transferred at the end of the fifth year. If a 10-percent tax were imposed on wage income, one would conclude that a burden of $1,000 was imposed annually. If a 10-percent tax were imposed on the transfer of wealth, one might conclude that a burden of $5,801.90 was imposed at the end of the fifth year. If, after paying the wage tax, the taxpayer had invested the remaining $9,000 each year to earn five percent, the taxpayer’s holding would be $52,217.10 at the end of five years. This is the same value that would remain under the wealth tax ($58,019.00 less $5,801.90). Thus, it is misleading to say that the burden of the wage tax is $1,000 in each year while the burden of the transfer tax is $5,801.90 in only the fifth year. It may be more appropriate to allocate the transfer tax burden over the years in which the capital income was earned.93

Wealth taxes, saving, and investment

Taxes on accumulated wealth are taxes on the stock of capital held by the taxpayer. As a tax on capital, issues similar to those that arise in analyzing any tax on the income from capital arise. In particular, while economic analysis concludes that in the long run owners of domestic capital are more easily able to escape some of the burden of the tax such that a tax on capital is at

91 Economists call income and consumption “flow” concepts. In simple terms, a flow can only be

measured by reference to a unit of time. Thus, one refers to a taxpayer’s annual income or monthly consumption expenditures.

92 Economists call wealth a “stock” concept. A stock of wealth, such as a bank account, may generate a flow of income, such as annual interest income.

93 James Poterba, “The Estate Tax and After-Tax Investment Returns,” in Joel B. Slemrod, ed., Does Atlas Shrug? The Economic Consequences of Taxing the Rich (New York and Cambridge: Russell Sage Foundation and Harvard University Press), 2000. Poterba converts the estate tax to a tax on capital income with the effective tax rate depending on the statutory tax rate as well as the potential taxpayer’s mortality risk.



32

least partially passed on to labor, there is no consensus among economists on the extent to which the incidence of taxes on the income from capital is borne by owners of capital in the form of reduced returns, or whether reduced returns cause investors to save less and provide less capital to workers, thereby reducing wages in the long run.94 A related issue is to what extent individuals respond to increases (or decreases) in the after-tax return to investments by decreasing (or increasing) their saving. Again, there is no consensus in either the empirical or theoretical economics literature regarding the responsiveness of saving to after-tax returns on investment.95

Some economists believe that an individual’s bequest motives are important to understanding saving behavior and aggregate capital accumulation. If estate and gift taxes alter the bequest motive, they may change the tax burdens of taxpayers other than the decedent and his or her heirs.96 It is an open question whether the bequest motive is an economically important explanation of taxpayer saving behavior and level of the capital stock. For example, theoretical analysis suggests that the bequest motive may account for between 15 and 70 percent of the United States’ capital stock.97 Others believe the bequest motive is not important in national capital formation,98 and empirical analysis of the existence of a bequest motive has not

94 For a discussion of economic incidence of capital taxes in the context of taxes on business income, see

Joint Committee on Taxation, Modeling the Distribution of Taxes on Business Income (JCX-14-13), October 16, 2013.

95 See B. Douglas Bernheim, “Taxation and Saving” in Alan J. Auerbach and Martin Feldstein (eds.), Handbook of Public Economics, vol. 3, Elsevier Science Publishers, 2002, pp. 1173-1249, and Douglas W. Elmendorf, “The Effect of Interest-Rate Changes on Household Saving and Consumption: a Survey,” Finance and Economics Discussion Series, 96-27, (Board of Governors of the Federal Reserve System), 1996.

96 A discussion of why, theoretically, the effect of the estate tax on saving behavior depends upon taxpayers’ motives for intergenerational transfers and wealth accumulation is provided by William G. Gale and Maria G. Perozek, “Do Estate Taxes Reduce Saving?” in William G. Gale and Joel B. Slemrod (eds.), Rethinking the Estate Tax, The Brookings Institution, 2001. For a brief review of how different views of the bequest motive may alter taxpayer bequest behavior, see William G. Gale and Joel B. Slemrod, “Death Watch for the Estate Tax,” Journal of Economic Perspectives, vol. 15, Winter 2001, pp. 205-218.

97 See Laurence J. Kotlikoff and Lawrence H. Summers, “The Role of Intergenerational Transfers in Aggregate Capital Accumulation,” Journal of Political Economy, vol. 89, August 1981. Also see, Laurence J. Kotlikoff, “Intergenerational Transfers and Savings,” Journal of Economic Perspectives, vol. 2, Spring 1988. For discussion of these issues in the context of wealth transfer taxes see, Henry J. Aaron and Alicia H. Munnell, “Reassessing the Role for Wealth Transfer Taxes,” National Tax Journal, vol. 45, June 1992. For attempts to calculate the share of the aggregate capital stock attributable to the bequest motive, see Thomas A. Barthold and Takatoshi Ito, “Bequest Taxes and Accumulation of Household Wealth: U.S.-Japan Comparison,” in Takatoshi Ito and Anne O. Kreuger (eds.), The Political Economy of Tax Reform, The University of Chicago Press, 1992; and William G. Gale and John Karl Scholz, “Intergenerational Transfers and the Accumulation of Wealth,” Journal of Economic Perspectives, vol. 8, Fall 1994, pp. 145-160. Gale and Scholz estimate that 20 percent of the nation’s capital stock can be attributed to “intentional transfers” (including inter vivos transfers, life insurance, and trusts) and another 30 percent can be attributed to bequests, whether planned or unplanned.

98 Franco Modigliani, “The Role of Intergenerational Transfers and Life Cycle Saving in the Accumulation of Wealth,” Journal of Economic Perspectives, vol. 2, Spring 1988. In this article, Modigliani argues that 15 percent is more likely an upper bound.



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led to a consensus.99 Theoretically, it is an open question whether estate and gift taxes encourage or discourage saving, and there has been limited empirical analysis of this specific issue.100 By raising the after-tax cost of leaving a bequest, a more expansive estate tax may discourage potential transferors from accumulating the assets necessary to make a bequest. On the other hand, a taxpayer who wants to leave a bequest of a certain net size might save more in response to estate taxation to meet that goal. For example, some individuals purchase additional life insurance to have sufficient funds to pay the estate tax without disposing of other assets in their estate.

Wealth taxes and labor supply

As people become wealthier, they have an incentive to consume more of everything, including leisure time. Some, therefore, suggest that, by reducing the amount of wealth transferrable to heirs, transfer taxes may reduce labor supply of the parent, although it may increase labor supply of the heir. Over 120 years ago, Andrew Carnegie opined that “the parent who leaves his son enormous wealth generally deadens the talents and energies of the son, and tempts him to lead a less useful and less worthy life than he otherwise would . . . .”101 Furthermore, the estate tax could increase work effort of heirs as the benefits of the special-use valuation, and the exclusion for qualified family-owned business interests will be lost and recaptured if the assets fail to remain in a qualified use. While, in theory, increases in wealth should reduce labor supply, empirically economists have found the magnitude of these effects to

99 See B. Douglas Bernheim, “How Strong Are Bequest Motives? Evidence Based on Estimates of the

Demand for Life Insurance and Annuities,” Journal of Political Economy, vol. 99, October 1991, pp. 899-927. Bernheim finds that social security annuity benefits raise life insurance holdings and depress private annuity holdings among elderly individuals. He interprets this as evidence that elderly individuals choose to maintain a positive fraction of their resources in bequeathable forms. For an opposing finding, see Michael D. Hurd, “Savings of the Elderly and Desired Bequests,” American Economic Review, vol. 77, June 1987, pp. 298-312. Hurd concludes that “any bequest motive is not an important determinant of consumption decisions and wealth holdings.... Bequests seem to be simply the result of mortality risk combined with a very weak market for private annuities.” Ibid., p. 308.

100 Wojciech Kopczuk and Joel Slemrod, “The Impact of the Estate Tax on the Wealth Accumulation and Avoidance Behavior of Donors,” in William G. Gale and Joel B. Slemrod (eds.), Rethinking Estate and Gift Taxation, The Brookings Institution, 2001, use estate tax return data from 1916 to 1996 to investigate the impact of the estate tax on reported estates. They find a negative correlation between measures of the level of estate taxation and reported wealth. This finding may be consistent with the estate tax depressing wealth accumulation (depressing saving) or with the estate tax encouraging successful avoidance activity.

More recently, David Joulfaian, “The Behavioral Response of Wealth Accumulation to Estate Taxation: Time Series Evidence,” National Tax Journal, vol. 59, June 2006, pp. 253-268, examines the size of taxable estates and the structure of the estate tax and its effects on the expected rates of return to saving. While he emphasizes the sensitivity of the analysis to how individuals’ expectations about future taxes are modeled he concludes that “taxable estates are ten percent smaller because of the estate tax.”

101 Andrew Carnegie, “The Advantages of Poverty,” in The Gospel of Wealth and Other Timely Essays, Edward C. Kirkland (ed.), The Belknap Press of Harvard University Press, 1962, reprint of Carnegie from 1891.



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be small.102 In addition, the estate tax also could distort, in either direction, the labor supply of the transferor if it distorts his or her decision to make a bequest.

Wealth taxes, the distribution of wealth, and fairness

Some suggest that, in addition to their role in producing Federal revenue, Federal transfer taxes may help prevent an increase in the concentration of wealth. Overall, there are relatively few analyses of the distribution of wealth holdings in the economic literature.103 Conventional economic wisdom holds that the Great Depression of the 1930s and World War II substantially reduced the concentration of wealth in the United States, and that there had been no substantial change at least through the 1980s. More recently, some economists have studied the distribution of wealth and noted an increase in wealth concentration in the last several decades.104 Most analysts assign no role to tax policy in the reduction in wealth concentration that occurred between 1930 and 1945. Nor has any analyst been able to quantify what role tax policy might have played since World War II.105

102 For a review of this issue, see John Pencavel, “Labor Supply of Men: A Survey,” in Orley Ashenfelter

and Richard Layard (eds.), Handbook of Labor Economics, vol. I, North-Holland Publishing Co., 1986. For a direct empirical test of what some refer to as the “Carnegie Conjecture,” see Douglas Holtz-Eakin, David Joulfaian, and Harvey S. Rosen, “The Carnegie Conjecture: Some Empirical Evidence,” Quarterly Journal of Economics, vol. 108, May 1993, pp. 413-435. Holtz-Eakin, Joulfaian, and Rosen assess the labor force participation of families that receive an inheritance. They find that “the likelihood that a person decreases his or her participation in the labor force increases with the size of the inheritance received. For example, families with one or two earners who received inheritances above $150,000 [in 1982-1985 constant dollars] were about three times more likely to reduce their labor force participation to zero than families with inheritances below $25,000. Moreover, ... high inheritance families experienced lower earnings growth than low inheritance families, which is consistent with the notion that inheritance reduces hours of work.” Ibid., pp. 432-433. Theory suggests also that those who choose to remain in the labor force will reduce their hours worked or labor earnings. Holtz-Eakin, Joulfaian, and Rosen find these effects to be small.

103 For some exceptions, see Martin H. David and Paul L. Menchik, “Changes in Cohort Wealth Over a Generation,” Demography, vol. 25, August 1988; Paul L. Menchik and Martin H. David, “The Effect of Income Distribution on Lifetime Savings and Bequests,” American Economic Review, vol. 73, September 1983; and Edward N. Wolff, “Estimate of Household Wealth Inequality in the U.S., 1962-1983,” The Review of Income and Wealth, vol. 33, September 1987.

104 See, for example, Thomas Piketty and Gabriel Zucman, “Capital is Back: Wealth-Income Ratios in Rich Countries 1700-2010,” Quarterly Journal of Economics, vol. 129, no. 3, August 2014, pp. 1255-1310, and Alan J. Auerbach and Kevin Hassett, “Capital Taxation in the 21st Century,” National Bureau of Economic Research Working Paper No. 20871, January 2015.

105 See Michael K. Taussig, “Les inégalités de patrimoine aux Etats-Unis,” in Kessler, Masson, Strauss-Khan (eds.), Accumulation et Repartition des Patrimoines. Taussig estimates shares of wealth held by the top 0.5 percent of wealth holders in the United States for various years between 1922 and 1972. Wolff, in “Estimate of Household Wealth Inequality in the U.S., 1962-1983,” does not attribute any movements in wealth distribution directly to tax policy, but rather to the changes in the relative values of housing and corporate stock.

Wojciech Kopczuk and Joel Slemrod, “The Impact of the Estate Tax on Wealth Accumulation and Avoidance Behavior,” in William G. Gale, James R. Hines Jr., and Joel Slemrod (eds.), Rethinking Estate and Gift Taxation (The Brookings Institution) 2001, find mixed evidence. Using aggregate time series data, Kopczuk and Slemrod find a negative correlation between the share of wealth held by top wealth holders and the estate tax rates.



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The income tax does not tax all sources of income. Some suggest that by serving as a “backstop” for income that escapes income taxation, transfer taxes may help promote overall fairness of the U.S. tax system.106 Still others counter that to the extent that much wealth was accumulated with after-(income)-tax dollars, as an across-the-board tax on wealth, transfer taxes tax more than just those monies that may have escaped the income tax. In addition, depending upon the incidence of such taxes, it is difficult to make an assessment regarding the contribution of transfer taxes to the overall fairness of the U.S. tax system.

Even if transfer taxes are believed to be borne by the owners of the assets subject to tax, an additional conceptual difficulty is whether the tax is borne by the generation of the transferor or the generation of the transferee. The design of the gift tax illustrates this conceptual difficulty. A gift tax is assessed on the transferor of taxable gifts. Assume, for example, a mother makes a gift of $1 million to her son and incurs a gift tax liability of $400,000. From one perspective, the gift tax could be said to have reduced the mother’s current economic well-being by $400,000. However, it is possible that, in the absence of the gift tax, the mother would have given her son $1.4 million, so that the gift tax has reduced the son’s economic well-being by $400,000. It also is possible that the economic well-being of both was reduced. Of course, distinctions between the donor and recipient generations may not be important to assessing the fairness of transfer taxes if both the donor and recipient have approximately the same income.107

Federal estate taxation and charitable bequests

The two unlimited exclusions under the Federal estate tax are for bequests to a surviving spouse and for bequests to a charity. Because charitable bequests are deductible against the That finding would imply that the estate tax may mitigate the concentration of wealth among top wealth holders. Wojciech Kopczuk and Emmanuel Saez, “Top Wealth Shares in the United States, 1916-2000: Evidence from Estate Tax Returns,” National Tax Journal, vol. 57, September 2004, pp. 445-487, report a similar result. However, when Kopczuk and Slemrod use pooled cross section analysis to make use of individual estate tax return data, they find at best a weak relationship between estate tax rates and wealth holdings.

106 Based on the 1998 Survey of Consumer Finance, one study estimates expected unrealized capital gains at death represent 36 percent of total expected value of estates. For estates worth at least $10 million, unrealized capital gains at death represent 56 percent of the value of estates. For this group of estates, the largest component (72.3 percent) of unrealized gains is estimated to be attributable to unrealized capital gains on active businesses of decedents. James Poterba and Scott Weisbenner, “The Distributional Burden of Taxing Estates and Unrealized Capital Gains at Death,” in William G. Gale, James R. Hines, Jr., and Joel Slemrod (eds.), Rethinking Estate and Gift Taxation (Brookings Institution Press) 2001, pp. 422-449. In addition to the unrealized capital gains considered here, the value of other assets included in the value of an estate may have previously received favorable income tax treatment. For example, the Survey of Consumer Finance does not collect information on unrealized gains in retirement accounts. Brian K. Bucks, Arthur B. Kennickell, Traci L. Mach, and Kevin B. Moore, “Changes in U.S. Family Finances from 2004 to 2007: Evidence from the Survey of Consumer Finances,” Federal Reserve Bulletin, vol. 95, February 2009, p. A36-A37.

107 Researchers have found that the correlation of income between parents and children is less than perfect. For analysis of the correlation of income among family members across generations, see Gary R. Solon, “Intergenerational Income Mobility in the United States,” American Economic Review, vol. 82, June 1992, and David J. Zimmerman, “Regression Toward Mediocrity in Economic Stature,” American Economic Review, vol. 82, June 1992. These studies, however, examine data relating to a broad range of incomes in the United States and do not directly assess the correlation of income among family members with transferors subject to the estate tax.



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estate tax, the after-tax cost of a charitable bequest is lower than the after-tax cost of a transfer to an heir who is not a spouse.108 Economists refer to this incentive as the “price” or “substitution effect.” In short, the price effect says that if something is made cheaper, people will do more of it. Some analysts have suggested that the charitable estate tax deduction creates a strong incentive to make charitable bequests and that changes in Federal estate taxation could alter the amount of funds that flow to charitable purposes. The decision to make a charitable bequest arises not only from the incentive effect of a charitable bequest’s deductibility, or “tax price,” but also from what economists call the “wealth effect.” Generally the wealthier an individual is, the more likely he or she is to make a charitable bequest, and the larger the bequest will be. Because the estate tax diminishes the amount of wealth available to an heir, the wealth effect would suggest repeal of the estate tax could increase charitable bequests.

A number of studies have examined the effects of estate taxes on charitable bequests. Most of these studies have concluded that, after controlling for the size of the estate and other factors, deductibility of charitable bequests encourages taxpayers to provide charitable bequests.109 Some analysts interpret these findings as implying that reductions in estate taxation could lead to a reduction in funds flowing into the charitable sector. This is not necessarily the case, however. Some charitable bequests may substitute for lifetime giving to charity, in part to take advantage of the greater value of the charitable deduction under the estate tax than under the income tax that results from the lower marginal income tax rates and limitations on annual

108 Economists note that when expenditures on specified items are permitted to be deducted from the tax base, before the computation of tax liability, the price of the deductible item is effectively reduced by a percentage equal to the taxpayer’s marginal tax rate. Assume, for example, a decedent has a $1 million taxable estate and that the marginal, and average, estate tax rate was 40 percent. This means that the estate tax liability would be $400,000. A net of $600,000 would be available for distribution to heirs. If, however, the decedent had provided that his estate make a charitable bequest of $100,000, the taxable estate would equal $900,000 and the estate tax liability would be $360,000. By bequeathing $100,000 to charity, the estate’s tax liability fell by $40,000. The net available for distribution to heirs after payment of the estate tax and payment of the charitable bequest would be $540,000. The $100,000 charitable bequest reduced the amount of funds available to be distributed to heirs by only $60,000. Economists say that the $100,000 charitable bequest “cost” $60,000, or that the “price” of the bequest was 60 cents per dollar of bequest. More generally, the “price” of charitable bequest equals (1 - t), where t is the estate’s marginal tax rate.

109 For example, see Charles T. Clotfelter, Federal Tax Policy and Charitable Giving, University of Chicago Press, 1985; David Joulfaian, “Charitable Bequests and Estate Taxes,” National Tax Journal, vol. 44, June 1991, pp. 169-180; and Gerald Auten and David Joulfaian, “Charitable Contributions and Intergenerational Transfers,” Journal of Public Economics, vol. 59, 1996, pp. 55-68. David Joulfaian, “Estate Taxes and Charitable Bequests by the Wealthy,” National Tax Journal, vol. 53, September 2000, pp. 743-763, provides a survey of these studies and presents new evidence. Each of these studies estimates a tax price elasticity in excess of 1.6 in absolute value. This implies that for each 10-percent reduction in the tax price, where the tax price is defined as one minus the marginal tax rate, there is a greater than 16-percent increase in the dollar value of charitable bequests. Such a finding implies that charities receive a greater dollar value of bequests than the Treasury loses in forgone tax revenue. In a more recent study, Michael J. Brunetti, “The Estate Tax and Charitable Bequests: Elasticity Estimates Using Probate Records,” National Tax Journal, vol. 58, June 2005, pp. 165-188, finds price elasticities in excess of 1.2.

Not all studies find such responsiveness of charitable bequests to the marginal estate tax rate. Thomas Barthold and Robert Plotnick, “Estate Taxation and Other Determinants of Charitable Bequests,” National Tax Journal, vol. 37, June 1984, pp. 225-237, estimated that marginal tax rates had no effect on charitable bequests.



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lifetime giving. If this is the case, reductions in the estate tax could lead to increased charitable giving during the taxpayer’s life. On the other hand, some analysts have suggested that a more sophisticated analysis is required recognizing that a taxpayer may choose among bequests to charity, bequests to heirs, lifetime gifts to charity, and lifetime gifts to heirs and recognizing that lifetime gifts reduce the future taxable estate and consumption. In this more complex framework, reductions in estate taxation could reduce lifetime charitable gifts.110

Federal transfer taxes and complexity

Critics of Federal transfer taxes document that these taxes create incentives to engage in avoidance activities. Some of these avoidance activities involve complex legal structures and can be expensive to create. Incurring these costs, while ultimately profitable from the donors’ and donees’ perspective, is socially wasteful because time, effort, and financial resources are spent that lead to no increase in productivity. Such costs represent an efficiency loss to the economy in addition to whatever distorting effects Federal transfer taxes may have on other economic choices such as saving and labor supply discussed above. For example, in the case of family-owned businesses, such activities may impose an ongoing cost by creating a business structure to reduce transfer tax burdens that may not be the most efficient business structure for the operation of the business. Reviewing more complex legal arrangements increases the administrative cost of the Internal Revenue Service. There is disagreement among analysts regarding the magnitude of the costs of avoidance activities.111 It is difficult to measure the extent to which any such costs incurred are undertaken from tax avoidance motives as opposed to succession planning or other motives behind gifts and bequests.

Alternatives to the current U.S. estate tax system

Some argue that Congress should consider an alternative structure for taxing transfers of wealth. The choice of one form of wealth transfer tax system over another necessarily will involve tradeoffs among efficiency, equity, administrability, and other factors. A determination whether one system is preferable to another could be made on the basis of each system’s relative success in achieving one or a majority of these goals, without sacrificing excessively the achievement of the others. Alternatively, such a determination could be made based on which system provides the best mix of efficiency, equity, and administrability.

110 Auten and Joulfaian, “Charitable Contributions and Intergenerational Transfers,” attempted to estimate

this more complex framework. Their findings suggest that reductions in estate taxation would reduce charitable contributions during the taxpayer’s life.

111 Joint Economic Committee, The Economics of the Estate Tax, December 1998, has stated “the costs of complying with the estate tax laws are roughly the same magnitude as the revenue raised.” Richard Schmalbeck, “Avoiding Federal Wealth Transfer Taxes,” in William G. Gale and Joel B. Slemrod (eds.), Rethinking Estate and Gift Taxation (The Brookings Institution) 2001, disagrees writing “[a]bout half of the estate planners consulted in the preparation of this paper reported that they had rather standard packages that they would make available to individuals who would leave estates in the three to ten million range that might be provided for as little as $3000 to $5000.” See William G. Gale and Joel B. Slemrod, “Life and Death Questions About the Estate and Gift Tax,” National Tax Journal, vol. 53, December 2000, pp. 889-912, for a review of the literature on compliance cost.



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The United States, State governments, and foreign jurisdictions tax transfers of wealth in many different ways. Some wealth transfer tax systems, for example, impose a tax on the transferor. Such systems include the U.S. estate and gift tax system, which imposes a gift tax on certain gratuitous lifetime transfers, an estate tax on a decedent’s estate, and a generation skipping transfer tax on certain transfers that skip generations. Another approach that involves imposition of a tax on a transferor is a “deemed-realization” approach, under which a gratuitous transfer is treated as a realization event and the gain on transferred assets, if any, generally is taxed to the transferor as capital gain.

Other wealth transfer tax systems tax the transferee of a gift or bequest.112 Such systems include inheritance (or “accessions”) tax systems, under which a tax is imposed on the recipient of a gratuitous transfer. Some jurisdictions do not impose a separate tax, but instead treat receipts of gifts or bequests as gross income of the recipient under the income tax system (an “income inclusion approach”).

Regardless of whether the tax is imposed on the transferor or the transferee, some commentators assert that the real economic burden of any approach to taxing transfers of wealth falls on the recipients, because the amount received effectively is reduced by the amount of tax paid by the transferor or realized by the transferee.113 Some commentators argue that systems that impose a tax based on the circumstances of the transferee –such as an inheritance tax or an income inclusion approach – are more effective in encouraging dispersal of wealth among a greater number of transferees and potentially to lower-income beneficiaries. Others assert that such systems promote fairness in the tax system. However, the extent to which one form of transfer tax system in practice is more effective than another in achieving these goals is not clear.

Wealth transfer tax systems other than an estate tax also may present benefits or additional challenges in administration or compliance. Inheritance taxes or income inclusion systems, for example, may reduce the need for costly tax planning in the case of certain transfers between spouses. At the same time, to the extent such systems are effective in encouraging distributions to multiple recipients in lower tax brackets, they may be susceptible to abuse such as through the use of multiple nominal recipients as conduits for a transfer intended for a single beneficiary.

112 Eight states have some form of Inheritance Tax. See McGuire Woods LLP State Death Tax Chart,

Revised March 26, 2012, available at http://www.mcguirewoods.com/news-resources/publications/taxation/state_death_tax_chart.pdf .

113 See, e.g., Lily L. Batchelder, “Taxing Privilege More Effectively: Replacing the Estate Tax with an Inheritance Tax,” The Hamilton Project, The Brookings Institution, Discussion Paper 2007-07, June 2007, p. 5; “Alternatives to the Current Wealth Transfer Tax System,” in American Bar Association, Task Force on Federal Wealth Transfer Taxes, “Report on Reform of Federal Wealth Transfer Taxes,” 2004, p. 171, app. A.; Joseph M. Dodge, “Comparing a Reformed Estate Tax with an Accessions Tax and an Income-Inclusion System, and Abandoning the Generation-Skipping Tax,” SMU Law Review, vol. 56, 2003, pp. 551, 556.



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Wealth taxes and small business

Regardless of any potential effect on aggregate saving, the scope and design of the transfer tax system may affect the composition of investment. In particular, some observers note that the transfer tax system may impose special cash flow burdens on small or family-owned businesses. They note that if a family has a substantial proportion of its wealth invested in one enterprise, the need to pay estate taxes may force heirs to liquidate all or part of the enterprise or to encumber the business with debt to meet the estate tax liability. If the business is sold, while the assets generally do not cease to exist and remain a productive part of the economy, the share of business represented by small or family-owned businesses may be diminished by the estate tax. If the business borrows to meet estate tax liability, the business’s cash flow may be strained. There is some evidence that many businesses may be constrained in the amount of funds they can borrow. If businesses are constrained, they may reduce the amount of investment in the business and this would be a market inefficiency.114 One study suggests that reduction in estate taxes may have a positive effect on the survival of an entrepreneur’s business.115

Others argue that potential deleterious effects of the estate tax on investment by small or family-owned businesses are limited. The basic exclusion amount is $5.43 million per decedent for decedents dying in 2015. As a result, small business owners can obtain an effective exclusion of up to $10.86 million per married couple for decedents dying in 2015, and other legitimate tax planning can further reduce the burden on such enterprises. For example, lifetime gifts to heirs of interests in the closely held business reduce the eventual estate tax liability attributable to business assets. Alternatively, lifetime gifts of cash or securities may provide funds to heirs to meet some or all of an estate tax liability that may be attributable to closely held business assets. Some analysis questions whether, in practice, small businesses need to liquidate operating assets to meet estate tax liabilities. Also, as described above, sections 2032A and 6166 are provided to reduce the impingement on small business cash flow that may result from an estate tax liability. Others have argued that estate tax returns report a small fraction of the value

114 Steven M. Fazzari, R. Glenn Hubbard, and Bruce C. Petersen, “Financing Constraints and Corporate

Investment,” Brookings Papers on Economic Activity, 1988, pp. 141-195.

115 Douglas Holtz-Eakin, David Joulfaian, and Harvey S. Rosen, “Sticking It Out: Entrepreneurial Survival and Liquidity Constraints,” Journal of Political Economy, vol. 102, February 1994, pp. 53-75. Holtz-Eakin, Joulfaian, and Rosen study the effect of receipt of an inheritance on whether an entrepreneur’s business survives rather than whether an on-going business that is taxed as an asset in an individual’s estate survives. They find that “the effect of inheritance on the probability of surviving as an entrepreneur is small but noticeable: a $150,000 inheritance raises the probability of survival by about 1.3 percentage points,” and “[i]f enterprises do survive, inheritances have a substantial impact on their performance: the $150,000 inheritance ... is associated with a nearly 20-percent increase in an enterprise’s receipts.” Ibid., p.74.

These results do not necessarily imply that the aggregate economy is made better off by receipt of inheritances. Survival of the entrepreneur may not be the most highly valued investment that could be made with the funds received. For example, Francisco Perez-Gonzalez, “Inherited Control and Firm Performance,” American Economic Review, vol. 96, December 2006, pp. 1559-1589, finds that where the incoming CEO is related to the departing CEO, or to a founder, the firm underperforms in terms of profitability and other financial measures.



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of decedents’ estates thereby mitigating any special burden that the estate tax may impose on small business.116

It is difficult to assess the degree to which estate tax impedes the survival and future growth of a closely held small business. Any tax payment reduces funds available to the heirs, but at the choice of the heirs, some or all of the reduction in funds could come from reduced personal consumption by the heirs rather than by reduced future business investment. Similarly, rather than reduce business investment, the decedent may have chosen to reduce his or her personal consumption to assure that the business would be adequately funded after payment of any transfer taxes.

Examination of 2001 data

A study of estate returns of persons who died in 2001 shows that many estates that claimed benefits under sections 2032A, 2057, or 6166 held liquid assets nearly sufficient to meet all debts against the estate and that only 2.4 percent of estates that reported closely held business assets and agricultural assets elected the deferral of tax under section 6166.117 This study uses detailed estate tax return data to calculate a liquidity ratio, the ratio of liquid assets (cash, cash management accounts, State and local bonds, Federal government bonds, publicly traded stock, and insurance on the life of the decedent) to the sum of the net estate tax plus mortgages and liens. A liquidity ratio of one or more implies that the estate has liquid assets sufficient to pay the net estate tax plus pay off all mortgages and liens. The study found that in 2001, on average, this ratio exceeded three for estates of less than $2.5 million claiming benefits of the special deduction for qualified family owned business assets or the section 2032A special use valuation.118 This means that, on average such estates had $3 in liquid assets for every $1 of estate tax liability and mortgage and lien. The study found that for estates of less than $2.5 million electing deferral of tax, the average liquidity ratio was slightly larger than one.119

116 See George Cooper, A Voluntary Tax? New Perspectives on Sophisticated Tax Avoidance (The

Brookings Institution) 1979. Also, see B. Douglas Bernheim, “Does the Estate Tax Raise Revenue?” in Lawrence H. Summers (ed.), Tax Policy and the Economy 1 (The MIT Press) 1987; and Alicia H. Munnell with Nicole Ernsberger, “Wealth Transfer Taxation: The Relative Role for Estate and Income Taxes,” New England Economic Review, November/December 1988. These studies pre-date the enactment of chapter 14 of the Code. The purpose of chapter 14 is to improve reporting of asset values in certain transfers. Nevertheless, planning opportunities remain whereby small business owners can reduce the cash required to meet an estate tax obligation, see Joint Committee on Taxation, Options to Improve Tax Compliance and Reform Tax Expenditures (JCS-2-05), January 27, 2005. The Joint Committee staff discusses the ability to use valuation discounts and lapsing trust powers effectively to shelter business (and other) assets from the estate tax on pages 396-408.

117 Martha Eller Gangi and Brian G. Raub, “Utilization of Special Estate Tax Provisions for Family-Owned Farms and Closely Held Businesses,” SOI Bulletin, 26, Summer 2006, pp. 128-145. Gangi and Raub report that in 2001 of 12,683 estates with farm real estate, 831 elected special use valuation; of 15,612 estates with closely held businesses or agri-business assets, 1,144 claimed a deduction for qualified family-owned business interests; and 382 estates elected to defer payment of the estate tax.

118 Ibid., Figures D and I.

119 Ibid., Figure N.



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A liquidity ratio of one or more suggests that closely held business assets need not be sold, nor need a loan be incurred, to pay the estate tax. While the existence of liquid assets can insure that core business assets are unencumbered by the estate tax, the business’s ability to function could be adversely affected by the reduction in liquid assets. Ongoing businesses need liquid assets in order to purchase raw materials, pay labor, finance expansion, and engage in other routine business activities. The greater the liquidity ratio is above one, the less likely that on-going business needs are impaired. The study found that generally all estates claiming special use valuations had an average liquidity ratio of at least one. For larger estates claiming benefits of the special deduction for qualified family owned business assets or deferral of tax, liquidity ratios averaged 0.5 or more.120 While a liquidity ratio of less than one suggests that it is likely that closely held business assets would be impaired by the estate tax liability, it is important to remember the limitations of the estate tax data. These data do not show pre-death estate planning transfers of assets to the heirs who might ultimately be running the business. For example, the purchase of life insurance by the heirs is a common planning technique to insure that business assets need not be sold to meet estate tax liabilities. Insurance amounts paid on the death of the decedent to a person other than the estate are not included as liquid assets for the purpose of computing the liquidity ratios reported in the study.121

Examination of 2011 data

A limitation of the study discussed above is that it reports the average liquidity ratio. If there is substantial variation in the way owners of closely held business assets manage their affairs, an average does not provide sufficient detail as to the extent to which the estate tax may or may not be thought to impair the continuity of closely held businesses upon the death of an owner.

In Tables 5 though 7, below, the staff of the Joint Committee on Taxation replicates the computation of the liquidity ratio on the 2011 estates with farm assets and closely held stock, but in addition to reporting the overall average liquidity ratio, the tables report average liquidity ratios from the second and ninth deciles of the distribution of such returns. Specifically, Tables 5 and 6 report liquidity ratios for 2011 estates that included farm property as an asset in the estate (1,275 estates) and estates that included farm property that claimed the special use valuation (58 estates). Table 5 reports liquidity ratios for all such estates, while Table 6 reports liquidity ratios for those estates with an estate tax liability (“taxable estates”). The first row reports the average liquidity ratio of all 2011 estates that included farm property as an asset in the estate and all 2011 estates that included farm property that also claimed the special use valuation. For this purpose, the JCT staff assigns a zero liquidity ratio to estates with no tax liability.122 In order to provide

120 Ibid., Figures D, I, and N.

121 On the other hand, when resources are used to purchase insurance, those resources are no longer available for investment opportunities.

122 This is not conceptually correct as mathematically if an estate has any liquid assets and no tax or debt liability the liquidity ratio would be infinite. An infinite value would render reported averages as meaningless. However, it is important to recognize that an estate could also have liquidity ratio of zero if it had no liquid assets



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another measure of liquidity, the JCT staff also reports the percentage of estates that are “well funded.” A well-funded estate is an estate whose liquidity ratio is at least one or which has no tax liability. The JCT staff ranks and numbers all estates with farm property and all estates with farm property claiming a special use valuation from the estate with the lowest liquidity ratio to the estate with the highest liquidity ratio. The second decile of estates with farm property is contained within the first 689 estates with a liquidity ratio of zero; the second decile of estates with farm property claiming the special use valuation is contained within the first 23 estates with a liquidity ratio of zero. Likewise the ninth deciles are estates with farm property numbered 1,020 to 1,148 and for estates with farm property claiming the special use valuation numbered 46 to 52. The second row reports the average liquidity ratio for the second decile, the third row reports the median liquidity ratio, and the fourth row reports the average liquidity ratio for the ninth decile. The fifth row presents the percentage of estates that are well funded.

Table 5.–Liquidity Ratios for Estates with Farm Property and Estates with Farm Property Claiming Benefits Under Sec. 2032A

2011 Decedents

All Estates including Farm Property

Estates including Farm Property and claiming special-use valuation

Average liquidity ratio 3.3 2.6 Average liquidity ratio of the second decile 0 0

Median liquidity ratio 0 0.7 Average liquidity ratio of the ninth decile 4.9 4.2 Percent of estates that are well-funded 89 84

and some, however modest, estate tax or debt liability. In the 2011 data almost all of the zero liquidity ratios are estates with no estate tax liabilities.



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Table 6.–Liquidity Ratios for Taxable Estates with Farmland and Estates with Farmland Claiming Benefits Under Sec. 2032A

2011 Decedents

All Estates including Farm Property

Estates including Farm Property and claiming special-use valuation

Average liquidity ratio 7.2 4.5 Average liquidity ratio of the second decile 0.6 0.5

Median liquidity ratio 2.8 1.7 Average liquidity ratio of the ninth decile 10.4 8.8 Percentage of estates that are well-funded 77 73

Tables 5 and 6 present rather similar results. The majority of estates with farm property and those claiming benefits of section 2032A have either a liquidity ratio of zero (meaning no estate tax liability) or a liquidity ratio of one or more. In Table 6 the average liquidity ratio in the second decile of estates with farm property is less than one. That is, the estate’s estate tax liability and other debts exceed the value of liquid assets contained in the estate. For taxable estates claiming the special-use valuation the liquidity ratio of half of the estates exceeds 1.7. These data suggest that most estates with farm property and estates that claim the special use valuation generally are not directly impaired by an estate tax liability. In 2011, these estates generally included sufficient liquid assets to pay the estate tax, if any, without necessitating a sale of farmland.123

In 2011, an estate could claim benefits under section 2032A and reduce the value of the estate below the threshold at which any estate tax would be liable. Unlike section 2032A, section 6166 is only beneficial to an estate if the estate has an estate tax liability after application of the provision. The second column of Table 7 below reports liquidity ratios for estates with closely held stock. The third column of Table 7 reports liquidity ratios for those estates that defer payment of the estate tax liability under section 6166. Comparison of column three to column two indicates that estates that use the deferred payment of section 6166 have lower liquidity ratios than all estates that include closely held stock. Such a result is consistent with the purpose of section 6166, to provide deferral when sale of closely held business assets might otherwise be necessary to meet an estate tax obligation.

123 The continuing operation of the farm could be impaired by a reduction in liquid operating capital.



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Table 7.–Liquidity Ratios for Estates with Closely Held Stock and Estates Electing to Defer Payment Under Sec. 6166

2011 Decedents1

All estates including closely held business assets

All estates including closely held business assets and electing deferral of tax liability under sec. 6166

Average liquidity ratio 10.1 0.5 Average liquidity ratio of the second decile 0 0. 1 Median liquidity ratio 0 0.4 Average liquidity ratio of the ninth decile 3.7 0.9 Percent of estates that are well-funded 89 13

1 The total number of estates with closely held stock was 2,745. Of those estates, 88 made an election under section 6166.

More recent data

As described previously, several Code provisions may reduce the burden of the estate tax borne by small or family-owned businesses. Table 8,124 below, presents data from estate tax returns filed in 2013 on the utilization of these provisions in comparison to all estate tax returns filed. In 2013, among estates with a positive estate tax liability, approximately three percent elected deferral under section 6166. Among with a positive estate tax liability, approximately 1.4 percent claimed a special use valuation under section 2032A.

124 This is similar to Table 7 in JCX-108-07, but reports data from estate tax returns filed in a more recent

year. The 2003 included information on estates that claimed benefits under section 2057. The special deduction available under section 2057 was not available for estates in 2013.



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Table 8.–Estates Claiming a Special Use Valuation or Electing Deferral of Tax Liability, Returns Filed in 2013

Item All Estates

Number of returns filed 10,568

Number of taxable returns 4,687 Number of returns claiming a special use valuation under sec. 2032A 128 Number of taxable returns claiming a special use valuation under sec. 2032A 65

Number of returns making sec. 6166 election 147 Number of returns claiming a special use valuation and making sec. 6166 election 19

Source: JCT staff tabulations from Statistics of Income data.

Table 9,125 below, reports data on the extent to which estates are made up of closely held stock or business interests. The data show that approximately 30 percent of estate tax returns filed in 2013 reported some holdings of closely held stock. For estates claiming the tax benefits provided by section 2032A or 6166, the holdings of closely held stock comprised more than half of the taxable estate. For estates holding closely held stock, but not claiming the tax benefits provided by section 2032A or 6166, closely held stock represented about one-sixth of the taxable gross estate on average.

125 This is similar to Table 8 in JCX-108-07, but reports data from estate tax returns filed in a more recent

year. The 2003 table included information on estates that claimed benefits under section 2057. The special deduction available under section 2057 was not available for estates in 2013.



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Table 9.–Closely Held Stock in Estate Tax Returns Filed in 2013

Item All Estates

Number of returns filed 10,568

Total gross estate (millions of dollars) 138,699

Value of closely held stock millions of dollars) 11,350

Value of closely held stock as a percentage of total gross estate 8.2%

Number of estates with closely held stock 3,115

Number of estates with closely held stock as a percentage of all returns filed 29.5%

Total gross estate of those estates with closely held stock (millions of dollars) 59,823

Number of estates with closely held stock and claiming benefits of secs. 2032A or 6166 126

Value of closely held stock as a percentage of the taxable gross estate of estates claiming benefits of secs. 2032A or 6166 52.4%

Number of estates with closely held stock not claiming benefits of secs. 2032A or 6166 2,989

Value of closely held stock as a percentage of the taxable gross estate of estates not claiming benefits of secs. 2032A or 6166 16.6%

Source: JCT staff tabulations from Statistics of Income data.



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V. SELECTED PROPOSALS TO MODIFY THE TAXATION OF WEALTH TRANSFERS

A. Overview

Lawmakers and the Administration have offered numerous proposals to modify the taxation of wealth transfers. This section describes recent proposals to: (1) repeal the estate and generation-skipping transfer taxes; (2) expand the taxation of wealth transfers by decreasing exemption amounts and increasing tax rates; (3) expand the transfer tax base; and (4) impose a new tax on the transfer of built-in gains at the time of a gift or upon a decedent’s death.

B. Proposals to Repeal the Estate and Generation-Skipping Transfer Taxes

In recent decades, several lawmakers and commentators have proposed repealing the estate and generation-skipping transfer taxes outright. Proponents sometimes argue that repeal is necessary in part because the transfer tax system imposes special cash flow burdens on small or family-owned businesses and farms. Opponents sometimes argue that, in addition to producing Federal revenue, the transfer tax system helps limit concentrations of wealth. These and other considerations are discussed in Part IV.B, above.

As is discussed in Part II, above, EGTRRA provided for the gradual phase-out of the estate and generation-skipping transfer taxes, followed by repeal of those taxes for only one year, i.e., for decedents dying and generation-skipping transfers made during 2010. This temporary repeal regime, however, ultimately was replaced with the present-law transfer tax rules.

More recently, Representative Kevin Brady introduced a bill to repeal the estate and generation-skipping transfer taxes.126 The “Death Tax Repeal Act of 2015” generally would terminate the estate and generation-skipping transfer taxes for decedents dying and generation-skipping transfers made after the date of enactment. The bill would retain the gift tax with the present-law exemption amount ($5 million, indexed for inflation occurring after 2011) and a top gift tax rate of 35 percent.127 Unlike the temporary repeal under EGTRRA, the bill would not modify the present-law rules for determining the basis of assets acquired by gift or bequest. Therefore, assets acquired from a decedent generally would be stepped up to fair market value under section 1014.

C. Proposals to Reduce Exemption Amounts and Increase Tax Rates

Other recent proposals would expand the reach of the present-law wealth transfer taxes by reducing exemption amounts, increasing tax rates, and broadening the transfer tax base. Arguments in favor of or in opposition to such proposals generally are the inverse of arguments regarding repeal of some or all of the wealth transfer taxes: proponents sometimes argue that a

126 H.R. 1105 (114th Cong., 1st Sess.).

127 A separate bill introduced by Congressman Tim Griffin, also titled the “Death Tax Repeal Act,” would repeal not only the estate and generation-skipping transfer taxes, but also the gift tax. H.R. 177 (113th Cong., 2d Sess.).



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more robust transfer tax system will produce additional revenue and help prevent further concentrations of wealth, while opponents sometimes argue that expanding the estate tax will harm owners of small businesses and farms. These and other considerations are discussed in greater detail in Part IV.B, above.

The Administration’s Fiscal Year 2016 budget proposal, for example, generally would put 2009-law estate and gift tax parameters back into place, but would retain the present-law rules regarding portability between spouses of unused exemption.128 The exemption amount would be $3.5 million for estate and generation-skipping transfer tax purposes and $1 million for gift tax purposes, with neither amount being indexed for inflation. The top estate and gift tax rate would be 45 percent.

The “Sensible Estate Tax Act of 2014,” introduced by Representative Jim McDermott, similarly would modify the present-law transfer tax rules by reducing the exemption amount and increasing the applicable tax rates.129 Among other changes, the bill would reduce the exemption amount for estate, gift, and generation-skipping transfer tax purposes to $1 million, indexed for inflation occurring after 2000. The bill also would increase the top marginal tax rate to 55 percent and provide for inflation indexing of the rate bracket cut-off points (i.e., the stated dollar amount above which each marginal rate included in the rate table applies).

D. Proposals to Expand the Transfer Tax Base

Other recent proposals seek to expand the transfer tax base by closing perceived loopholes that allow for avoidance of estate, gift, or generation-skipping transfer tax. The Administration’s 2016 Fiscal Year budget includes several such proposals, and Members of Congress have included some of these proposals in introduced bills. The subsections below describe three examples of proposals to broaden the transfer tax base.

Require a minimum term for grantor retained annuity trusts

One such proposal, for example, would modify the tax rules for grantor retained annuity trusts (“GRATs”), which often are used to minimize transfer tax liability. In a GRAT structure, the grantor generally retains a right to receive a stream of payments for a period of time, after which the assets that remain in the GRAT are distributed to the remainder beneficiaries, often heirs of the grantor. When the grantor funds the trust, he is treated as making a taxable gift to the remainder beneficiaries equal to the value of the remainder interest. That value is determined by deducting from the total value of assets transferred to the trust the value of the retained annuity interest, which is, in turn determined using annuity tables issued by the IRS. If the trust assets grow at a rate that exceeds the statutory interest rate assumed in the annuity tables, the excess appreciation ultimately will be transferred to the remainder beneficiaries, free of transfer tax. If,

128 Department of the Treasury, General Explanations of the Administration’s Fiscal Year 2016 Revenue

Proposals, February 2015, pp. 193-94.

129 H.R. 4061 (113th Cong. 2d Sess.).



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however, the grantor dies during the trust term, the portion of the trust assets necessary to satisfy the annuity are included in the grantor’s estate for estate tax purposes.

The GRAT structure allows taxpayers to fund GRATs aggressively, with little downside risk. In some cases, for example, taxpayers “zero out” a GRAT by structuring the trust so that the value of the annuity interest equals (or nearly equals) the entire value of the property transferred to the trust. Under this strategy, the value of the remainder interest and hence the value of any gift that is subject to gift taxation is deemed to be equal to or near zero. In reality, however, by funding GRATs with assets expected to significantly increase in value, taxpayers often achieve returns on trust assets substantially in excess of the returns assumed under the annuity tables, which allows any excess appreciation to pass to heirs without transfer taxation. Furthermore, grantors often structure GRATs with relatively short terms, such as two years, to minimize the risk that the grantor will die during the trust term, causing the assets to be included in the grantor’s estate. Taxpayers sometimes establish multiple, concurrent GRATs funded with different assets in an effort to increase the likelihood that at least one will succeed during any given period.

In its Fiscal Year 2016 budget, the Administration proposes to modify the tax rules for GRATs to require that the GRAT have a term of at least 10 years and that the remainder have a value equal to the greater of 25 percent of the value of assets contributed to the GRAT or $500,000 (but no more than the amount contributed).130 Similar proposals have been included in several introduced bills.131 The proposal generally seeks to introduce down-side risk into GRATs, minimizing or eliminating taxpayers’ ability aggressively to fund GRATs in an effort to outperform annuity assumptions with little risk of loss.

Limit the generation-skipping transfer tax exemption for dynasty trusts

Another proposal seeks to limit taxpayers’ ability to establish trusts that will exist in perpetuity and that will forever be exempt from the generation-skipping transfer tax. In general, where a taxpayer allocates generation-skipping transfer tax exemption to a trust in an amount equal to assets transferred to the trust, all future distributions from or terminations of interests in that trust will be exempt from generation-skipping transfer tax, no matter when they occur. Historically, this ability to create perpetually exempt trusts was mitigated by State law “rules against perpetuities” that limit the legal lifespan of a trust. In recent years, however, many States have repealed their rules against perpetuities, with the effect that taxpayers now can establish exempt trusts that will exist in perpetuity and which can grow quite large, allowing vast sums to be passed to future generations without transfer tax consequences. These trusts sometimes are referred to as dynasty trusts.

130 Department of the Treasury, General Explanations of the Administration’s Fiscal Year 2016 Revenue Proposals, February 2015, pp. 197-99.

131 See, e.g., sec. 6 of the “Sensible Estate Tax Act of 2014.” H.R. 4061 (113th Cong. 2d Sess.). A similar provision passed the U.S. House of Representatives three times in 2010. See sec. 307 of H.R. 4849 (111sth Cong., 2d Sess.), passed by the U.S. House of Representatives on March 25, 2010; sec. 531 of H.R. 5486 (111sth Cong., 2d Sess.), passed by the U.S. House of Representatives on June 15, 2010; and H.R. 4899 (111sth Cong., 2d Sess.), passed by the U.S. House of Representatives on July 1, 2010.



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In its Fiscal Year 2016 budget, the Administration proposes to modify the transfer tax laws to provide that, on the 90th anniversary of the creation of a trust, any generation-skipping transfer tax exemption allocated to the trust would terminate.132 Taxpayers thus could continue to create trusts that are exempt from generation-skipping transfer tax for a period of time, but the exemption could not exist in perpetuity. Similar proposals have been included in introduced bills.133

Require consistency in value for transfer and income tax purposes

A third proposal would coordinate the valuation rules for transfer and income tax purposes. The value of an asset for purposes of the estate tax generally is the fair market value at the time of death or at the alternate valuation date. The basis of property acquired from a decedent is the fair market value of the property at the time of the decedent’s death or as of an alternate valuation date, if elected by the executor. Under regulations, the fair market value of the property at the date of the decedent’s death (or alternate valuation date) is deemed to be its value as appraised for estate tax purposes.134 However, the value of property as reported on the decedent’s estate tax return provides only a rebuttable presumption of the property’s basis in the hands of the heir.135 Unless the heir is estopped by his or her previous actions or statements with regard to the estate tax valuation, the heir may rebut the use of the estate’s valuation as his or her basis by clear and convincing evidence.136

Generally the incentive exists for an executor of an estate or a donor of a lifetime gift to offer low estimates of the value of assets for estate or gift tax purposes in order to minimize the amount of transfer tax. For the purpose of determining gain or loss on an inherited asset or on an asset received by gift, however, generally the recipient would prefer a higher basis.137 The government is potentially whipsawed by inconsistent valuations.

132 Department of the Treasury, General Explanations of the Administration’s Fiscal Year 2016 Revenue

Proposals, February 2015, pp. 200-01.

133 See, e.g., sec. 7 of the “Sensible Estate Tax Act of 2014.” H.R. 4061 (113th Cong. 2d Sess.). For a different proposal relating to perpetual dynasty trusts, see Joint Committee on Taxation, Options to Improve Tax Compliance and Reform Tax Expenditures (JCS-02-05), January 27, 2005, pp. 392-95. The proposal generally prohibits the allocation of generation-skipping transfer tax exemption to a trust that can exist in perpetuity.

134 Treas. Reg. sec. 1.1014-3(a).

135 See Rev. Rul. 54-97, 1954-1 C.B. 113, 1954.

136 See Technical Advice Memorandum 199933001, January 7, 1999. For property acquired by gift, the basis of the property in the hands of the donee generally is the same as it was in the hands of the donor. However, for the purpose of determining loss on subsequent sale, the basis of property in the hands of the donee is the lesser of the donor’s basis or the fair market value of the property at the time of the gift. Sec. 1015(a).

137 This preference is especially clear in the case of a spouse of the decedent. That spouse will not, for example, bear the burden of an estate tax on his or her bequest. Other beneficiaries generally will bear the burden of the estate tax and therefore may have competing preferences.



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The proposal seeks to address this concern by requiring that the recipient’s basis of property equal the value used by the transferor for transfer tax purposes. The Administration included a version of this proposal in its Fiscal Year 2016 budget, requiring consistency both in the case of gifts and transfers at death. 138 The “Tax Relief Act of 2014,” introduced by Congressman Dave Camp, included a similar proposal, but limited its application to transfers at death.139

E. Proposal to Tax Built-in Gains at the Time of a Gift or upon Death

A proposal included in the Administration’s Fiscal Year 2016 budget would require the recognition of any built-in gain at the time of a gift or upon death.140 Under present law, capital gains generally are taxable only when an appreciated asset is sold or otherwise disposed of. A gift or bequest generally is not treated as a sale or disposition; therefore, there is no realization of built-in gain upon the gift or bequest of an appreciated asset. The recipient of a gift generally takes the donor’s basis in the assets transferred, such that the recipient generally recognizes gain on the appreciation at the time of a subsequent sale or disposition. A taxpayer who receives assets from a decedent, however, generally receives a basis equal to the fair market value of the asset as of the decedent’s death. As a result, any appreciation that occurred during the decedent’s life is never subjected to income tax.

The Administration’s proposal generally treats transfers of appreciated property by gift or at death as a sale of the property. As a result, the transferor (the donor of a gift or the deceased owner of an asset), would realize capital gain at the time of the transfer equal to the excess of the asset’s fair market value over the transferor’s basis in the asset. In the case of a decedent, the capital gain generally would be included on a final income tax return.

The proposal contains a number of special rules. First, gifts or bequests to a spouse would take the basis of the transferor, and no gain would be realized until the receiving spouse sells or disposes of the asset. The proposal exempts from capital gains tax transfers to charity and transfers of tangible personal property, such as household furnishings and personal effects. Each taxpayer also would be allowed an exclusion of $100,000 ($200,000 per married couple) of gain recognized upon gift or at death, with any unused amount portable to the surviving spouse. In addition, the present-law $250,000 per person exclusion for capital gain on a personal residence would apply to all residences, and any unused exclusion would be portable to a surviving spouse.

The present-law exclusion for capital gain on certain small business stock would apply. In addition, any appreciation of certain small family-owned and family-operated businesses would be deferred and recognized only when the business is sold by the recipient or ceases to be


139 H.R. 1 (113th Cong., 2d Sess.), sec. 1422.




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family-owned and operated. The proposal allows a 15-year fixed-rate payment plan for the tax on appreciated assets transferred at death, other than liquid assets (such as publicly traded stock) or businesses for which the deferral election is made.

The Administration argues that the proposal is necessary, because present-law capital gain rules unfairly favor wealthier taxpayers relative to less wealthy taxpayers.141 Specifically, the Administration states that when an individual has more resources than he or she needs during retirement such that the individual is able to leave appreciated assets to heirs, any built-in gain permanently escapes taxation. A less wealthy individual, on the other hand, often must spend down his or her assets during retirement and must pay tax on any realized gains. Furthermore, the Administration argues that the preferential treatment for assets held until death produces an inefficient lock-in effect on capital, i.e., taxpayers hold assets solely to avoid paying tax on gains, rather than more productively reinvesting capital. Opponents of the proposal might argue that a tax on built-in gain when assets are transferred by gift or at death, particularly when combined with the present-law wealth transfer taxes, will burden taxpayers, particularly owners of small businesses and family farms.

141 Ibid.



Bonus Issue

A Fiduciary Income Tax Primer

Philip N. Jones Duffy Kekel LLP, Portland, OR

Contents

1. Introduction ............................................................................. 1 2. Entities not Taxed as Trusts ................................................... 3 3. Tax Rates .................................................................................. 3 4. Simple vs. Complex Trusts; Credit Shelter Trusts .............. 4 5. Filing Thresholds .................................................................... 5 6. Estimated Taxes....................................................................... 5 7. The Decedent’s Final Tax Year and the First Tax Year of an Estate or Trust ..................................... 6 8. Formerly-Revocable Trust Election to Use a Fiscal Year ... 8 9. The Final Tax Year ................................................................. 9 10. Fiduciary Accounting Income .............................................. 10 11. Partnerships and S Corporations ........................................ 11 12. Distributable Net Income (DNI) .......................................... 12 13. Capital Gains and Losses ..................................................... 13 14. Exemptions ............................................................................. 14 15. Calculating Taxable Income; Deductions ........................... 14 16. The Net Investment Income Tax .......................................... 16 17. The Election to Take Deductions on the Fiduciary Income Tax Return ............................................................... 17 18. The Distribution Deduction ................................................. 19 19. Tax-Exempt Income .............................................................. 20

................................................................... 20 21. In-Kind Distributions ........................................................... 21 22. Charitable Deduction ............................................................ 22 23. The Sixty-Five Day Rule....................................................... 23

............................. 24 25. Income in Respect of a Decedent (IRD); Deductions in Respect of a Decedent (DRD) ...................... 25 26. Retirement Accounts ............................................................. 26 27. Separate Share Rule .............................................................. 28

......................................................................... 28 29. State Fiduciary Income Taxes .............................................. 29 30. Revocable Trusts and Grantor Trusts................................. 30 Selected Additional Research Materials...................................... 31 Appendices:

Appendix A: Miscellaneous Itemized Deductions of Trusts and Estates ...................................................................... 32

..... 33

Oregon Estate Planning

and AdministrationSection Newsletter

Volume XXXI, No. 4 October 2014

Published by theEstate Planningand AdministrationSection of theOregon State Bar

This issue of the Oregon Estate Planning and Administration Section Newsletter is available at http://oregonestateplanning.homestead.com/EstatePlanning_BonusOct14.pdf.



Chapter 4

Navigating the Sea Change—Planning for Married Clients

patriCK Green

Davis Wright Tremaine LLPPortland, Oregon

Contents

I. Sea Change . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–1

II. Historical Marital Planning—“Optimizing” or “Fine Tuning” the Marital Deduction. . . . . 4–4A. Multiplicity of Formulas to “Optimize” the Marital Deduction . . . . . . . . . . . . . 4–4B. Historical Preference? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–6

III. Post–ATRA 2012 World . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–6A. From “Optimizing” to “Maximizing” the Marital Deduction. . . . . . . . . . . . . . . 4–6B. Portability—To Elect or Not to Elect? . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–7C. Analyzing Planning for Marital Clients Today . . . . . . . . . . . . . . . . . . . . . . . 4–7D. Framework for Planning—Decision Tree . . . . . . . . . . . . . . . . . . . . . . . . . . 4–8

IV. Case Studies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–16A. Case Study #1—Married Couple with a $1,000,000 Oregon Estate . . . . . . . . . . . 4–16B. Case Study #2—Married Couple with a $2,000,000 Oregon Estate . . . . . . . . . . . 4–18C. Case Study #3—The Oregon $7,000,000 Estate . . . . . . . . . . . . . . . . . . . . . . 4–20D. Case Study #4—The Oregon $11,000,000 Estate . . . . . . . . . . . . . . . . . . . . . 4–23

Chapter 4—Navigating the Sea Change—Planning for Married Clients




I. SEA CHANGE

“A big and sudden change; a marked change: transformation” 1

Decades of “traditional estate planning” based upon avoiding the estate tax have been turned upside down due to the dramatic impact of the following, often non-complimentary, developments:

o Larger federal estate tax exemptions that are inflation adjusted

I.R.C. §2010(c)(3)(A): For purposes of this subsection, the basic exclusion amount is $5,000,000.

I.R.C. §2010(c)(3)(B) Inflation Adjustment

In the case of any decedent dying in a calendar year after 2011, the dollar amount in subparagraph (A) shall be increased by an amount equal to—

I.R.C. §2010(c)(3)(B)(i)

such dollar amount, multiplied by

I.R.C. §2010(c)(3)(B)(ii)

the cost-of-living adjustment determined under section 1(f)(3) for such calendar year by substituting “calendar year 2010” for “calendar year 1992” in subparagraph (B) thereof. If any amount as adjusted under the preceding sentence is not a multiple of $10,000, such amount shall be rounded to the nearest multiple of $10,000.

The impact of this is to increase the $5,000,000 basic exclusion amount, previously the “Applicable Exclusion Amount,” from $5,000,000 in 2010 to $5,430,000 or $10,860,000 for a married couple in 2015, an 8.6% increase in just four years. Assuming inflation rates of 3% or 6%, future exemptions could increase as follows:

Rate of Inflation

3% Individual

3% Couple 6% Individual

6% Couple

5 Years $6,294,858 $12,589,716 $7,266,565 $14,533,130 15 Years $8,459,763 $16,919,526 $13,013,311 $26,026,622 25 Years $11,369,214 $22,738,428 $23,304,858 $46,609,716

1 www.merriam-webster.com/dictionary



o Low state estate tax exemptions2

Oregon provides an exemption from the Oregon estate tax of $1,000,000, unindexed for inflation.

Washington’s estate exemption, indexed for inflation, is $2,054,000 for 2015.

o Higher federal and state income taxes and limitations on deductions3

Tax Oregon California Washington

Federal Ordinary

Income Tax Rate + Oregon

Federal Long- term Capital Gain Bracket

20% 20% 20% 39.6%

Federal Net Investment Income Excise Tax

3.8% 3.8% 3.8% 3.8%

State 9.9% 13.3% 0% 9.9% (Oregon) Total 33.7% 37.1% 23.8% 53.3% Effective Rate (state deduction against federal)

31.4% 33.9% 23.8% 49%

Effective Rate w/o 3.8%

27.92% 30.6% 20% 49%

2 ORS 118.010; RCW 83.100.020 3 IRC §1411 – 3.8% Medicare surtax on net investment income; IRC - Higher income tax brackets – new 39.6% (up from 35%) and increased long-term capital gain rate of 20% (up from 15%); Individuals – both rates apply if taxable income exceeds $413,200for single taxpayers and $464,850for married filing jointly; Trusts – New higher rates if taxable income exceeds $12,300 of taxable income for 2015. Effective rates also depend upon other factors such as the phase out of personal exemptions and itemized deductions (Pease amendments).



o Portability4

I.R.C. §2010(c)(2) Applicable Exclusion Amount

For purposes of this subsection, the applicable exclusion amount [“AEA”] is the sum of—

2010(c)(2)(A) the basic exclusion amount [“BEA”] , and

2010(c)(2)(B) in the case of a surviving spouse, the deceased spousal unused exclusion amount [“DSUE”].

A formula for the appropriate Applicable Exclusion amount is as follows:

AEA = BEA + DSUE

A detailed discussion of portability, the election, the computation of the deceased spouses unused exclusion amount (“DSUE”), the identification of the “last deceased spouse”, pros and cons of the portability election, remarriage and lifetime strategies are beyond the scope of this outline except to the extent that the case studies in this outline illustrate the use of portability in planning – a very major and important part of this presentation. Other scholarly presentations and articles have addressed considerations of portability, some of which are referenced in the accompanying bibliography. For purposes of this presentation, I am assuming that the estate value will increase between the first and second deaths of the married couple although it should be kept in mind that bases “step down” as well as “step up”.5

o Same sex marriages6 and “blended families”

Both Supreme Courts of the United States and of Oregon have ruled that couples in same sex marriages qualify for federal and state tax treatment applicable to married individuals of the opposite sex.

The SCOTUS Windsor case and the SCOSO Geiger v. Kitzhaber cases essentially expand the planning benefits available to married couples regardless of the gender of the couple provided that the marriages are recognized where married with Oregon benefits for Oregon domestic partnerships. Not all states recognize same sex marriages although cases challenging these prohibitions are headed to SCOTUS.

The prevalence of blended families, which often involve multiple marriages with children from previous marriages or relationships, expands the impact of using

4Initial Enactment: Tax Relief Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the “2010 TRA”). Now made permanent – see IRC §2010(c) 5 IRC §1014. 6 United States v. Windsor, 570 U.S. __, 133 S. Ct. 2675 (2013); Rev. Rul. 2013-17, 2013-38 I.R.B. 201 (August 28, 2013); Geiger v. Kitzhaber, 994 F. Supp.2d 1128; OAR 105-010-0018, effective January 1, 2014



portability to the advantage of the surviving spouse and the children. The value of a DSUE is considered a valuable asset over which much negotiation may occur in the creation of marital agreements. Also, in blended families, couples should consider irrevocable trusts for the surviving spouse that provide for the survivor but also provide for the children of the decedent to avoid conflicts among the surviving heirs and beneficiaries. This tension will likely involve credit shelter trusts, with benefits for the children, particularly if the current spouse is much younger than the deceased spouse, and with QTIP trust arrangements to allow portability elections at the death of the first spouse to die while designating children of the first spouse to die as remainder beneficiaries.

The incidence of same sex marriages and mixed families today greatly expand the relevance of planning for married couples.

o The huge shift from hard copy documents to digital assets7

While not directly impacting the complexity of analyzing the best choices for analyzing estate tax formulas for married couples, this shift certainly creates some challenges obtaining information unless the surviving spouse has access to online account information.

o Tax law changes: Proposals - Administrations “Green Book”8

Proposals, if enacted into legislation, could also dramatically impact estate planning for married couples. One such proposal would limit the step up in basis rules for assets in a decedent’s estate. This could result in higher income taxes upon the sale of assets for the surviving spouse’s heirs and beneficiaries as well as estate taxes.

Many scholarly articles, some with extensive mathematical analysis, have addressed each of these “sea change” developments. I have included citations to several articles throughout this outline. These sources thoroughly discuss the above developments, law changes and possible planning opportunities. The purpose, however, of this presentation is to focus on issue spotting, to develop an analytical planning approach and to provide tools and language for implementation of effective strategies in some common estate planning engagements.

II. HISTORICAL MARITAL PLANNING – “OPTIMIZING” OR “FINE TUNING” THE MARITAL DEDUCTION

A. Multiplicity of Formulas to “Optimize” the Marital Deduction.

“Optimizing” 9 the marital deduction is the strategy of obtaining just enough marital deduction to reduce the federal estate tax to zero or pretty close to it. The following

7 Uniform Law Commission – The Uniform Fiduciary Access to Digital Assets Act introduced in Oregon in 2015 as SB 369 (not yet enacted ) 8 General Explanations of the Administration’s Fiscal Year 2014 Revenue Proposals



material from my presentation "Playing the Hand you are Dealt - Administering the Marital Funding Formula and Advising the Taxable Estate" at the Oregon State Bar sponsored “Administering the Taxable Estate” CLE on November 20, 200910 summarizes the potpourri of formulas, provides examples and sample language. You may access this article (see link below) to study the variety of marital funding approaches. Here is an edited excerpt from that outline:

Formula. Marital funding formulas follow two main categories, pecuniary or fractional, with a third category involving a single fund that is neither pecuniary nor fractional but may utilize such approaches in making various elections within the single marital fund. There are five pecuniary and two fractional formulas. The nomenclature of the formulas breaks down as follows:

(1) Pecuniary.

(a) True worth marital

(b) Fairly representative marital

(c) Minimum worth marital

(d) True worth exemption (credit shelter)

(e) Fairly representative exemption (credit shelter)

(2) Fractional.

(a) Pro rata

(b) Pick and choose

(3) Single fund marital. Another category involves single fund marital trust funding with various elections available often made as a fractional and sometimes by pecuniary formulas. These would include the following:

(a) Divisible QTIP

(b) Clayton QTIP

(c) Reverse QTIP (for Generation Skipping Transfer Tax exemption)

9 Credit to author for recent characterization of the marital deduction planning as “optimizing” v. “maximizing” and summarizing objectives: Fujimoto, Marcia K., Graham & Dunn, PC, Seattle, WA, “Creatively Using Lifetime and Testamentary QTIP Trusts – A Federal and State of Washington Perspective”, September 2014 10 Link for access: http://www.dwt.com/people/PatrickJGreen/ Go to “Profiles” and click on “Publications” to obtain a link to the outline and PowerPoint: 11.20.09 "Playing the Hand you are Dealt - Administering the Marital Funding Formula and Advising the Taxable Estate"



B. Historical Preference?

Which formulas are used the most? Studies show that most practitioners repeatedly use only a few of the choices which tend to be the ones that they understand and favor. According to one study11 most of the respondents utilized the following marital formulas:

(1) Pre-residuary pecuniary true worth marital

(2) Reverse true worth marital

(3) Fractional pick & choose marital

Note however, that this study was compiled when many state inheritance taxes were not decoupled as now exists in many states, including Oregon. Also, this survey was conducted well before portability and higher exemptions came into law. Which of these formulas would be useful today?

III. POST-ATRA 201212 WORLD

Much to the surprise of many estate planning professionals, ATRA offered up generous exemptions following the 2012 scramble to establish and document large gifts arrangements before the exemptions reverted to lower levels anticipated by the law at that time. Due to these exemptions and the establishment of “portability”, much of the estate planning that has occurred to avoid estate tax has become unnecessary and perhaps harmful to our client’s beneficiaries given newly increased income tax rates imposed upon individuals and trusts. Employing traditional formulas designed to “optimize” the marital deduction and to avoid federal estate tax may now result in locking in the historical basis of assets at values included in the estate of the first spouse’s death, usually into a “credit shelter trust”13 Due to increasing longevity, the basis of assets in a credit shelter trust may be woefully below fair market value at the much later death of the surviving spouse. Sale of such assets by the beneficiaries can generate large income tax bills even though the estate would pass estate tax free for a “moderately wealthy” couple.14

A. From “optimizing” to “maximizing” the Marital Deduction.

The focus for today’s estate planning has shifted from “optimizing” the marital deduction to “maximizing” the marital deduction. We now must address three major estate tax objectives while attempting to address the increasingly important income tax objective and to weigh the multiple possible outcomes15. The problem, of course, is that meeting all of these objectives is

11 Moore & Pennell, Practicing What We Preach: Esoteric or Essential? , 27 U. Miami Inst. Est. Plan, ¶1211 (1993) (survey of University of Miami Estate Planning Instituted registrants) 12 American Taxpayer Relief Act of 2012 (“ATRA”), Pub. L. 112-240, 112h Cong. (Jan. 22, 2013) 13 “Credit Shelter Trust” will be used in this outline to describe what is also known as a “bypass trust” or “exemption trust” designed to capture the full exemption equivalent provided by I.R.C. §2010, currently $5,430,000 in 2015. 14 Up to a net worth of $10,680,000 in 2015. 15Credit to author for summarizing objectives and contrasting marital trust strategies: Fujimoto, Marcia K., Graham & Dunn, PC, Seattle, WA, “Creatively Using Lifetime and Testamentary QTIP Trusts – A Federal and State of Washington Perspective”, September 2014



becoming increasingly difficult without implementing new and often complex strategies. These objectives may be stated as follows:

Estate tax objectives:

1. Maximize amount passing to spouse estate tax free (done by “optimizing” the federal marital share)

2. Delay federal and state estate tax until death of surviving spouse (on the marital share, Oregon Special Marital Property, Washington QTIP, etc.)

3. Maximize amount passing to beneficiaries at death of surviving spouse

Income tax objective and comparison:

1. Maximize basis for income tax purposes at death of surviving spouse (done with maximizing federal marital share)

2. Weighing the income against the estate tax outcomes.

B. Portability – to elect or not to elect?

Advising the surviving spouse on electing portability at the deceased spouse’s death involves many assumptions and calculations. Since the outcomes can vary significantly based upon multiple unknown future factors, it will become increasingly important to document the decision and the process involved in arriving at that decision. The surviving spouse’s heirs and beneficiaries will have the benefit of hindsight and will be able to present calculations that, based upon now known facts, will show the dollar outcomes disputing the previous decision. If the surviving spouse chooses not to elect portability, the conventional wisdom suggests that the attorney place a declaration signed by the surviving spouse that they have been fully advised of the consequences of forgoing the election into the file to document the decision (sample letter cited in referenced article).16

C. Analyzing Planning for Marital Clients today.

How does our experience with traditional marital formula planning work in today’s environment and what are the most effective formulas? Does the sea change require that we throw out the traditional formulas including the credit shelter trust? Is the credit shelter trust really “dead”. 17 Ms. Zeydel’s articles introduce terminology that addresses the use of “portability” and provide a framework for an analysis for structuring planning. Other articles list factors to consider in addressing the need for trust planning for a surviving spouse and electing

16 Cheyne, Jeffrey, “The Perils of Portability”, Oregon Estate Planning and Administration Section Newsletter, Vol. XXXI, No. 2, May 2014 17Zeydel, Diana S.C., “Portability or No: The Death of the Credit Shelter Trust,” Journal of Taxation, May 2013; “Planning With Portability”, Portland Estate Planning Council Annual Seminar, February 2014 and other article.



portability. 18 Another author provides an excellent decision tree for developing a plan for today’s married clients. 19

D. Framework for Planning – Decision Tree

1. Lifetime Trust or Will?

How important is avoiding probate to this couple? Will the extra cost of establishing and funding a revocable living trust be worth the benefits of a trust administration versus an estate administration (incapacity, privacy, avoidance of court fees, speed, etc.)?

2. Irrevocable Trust for Surviving Spouse or Not?

A number of factors control this decision:

• Non-tax issues such as in marriages where there are children from previous marriages or relationships, where the possibility of remarriage and change in disposition to the decedent’s children may occur and where the need for management, avoidance of undue influence and asset protection may be present.

• Costs of trust administration during life of surviving spouse (trustee, accounting and legal fees and possible higher income taxes)

3. Portability Approaches – to elect or not to elect that is the question: Factors to consider:

• Cost. Filing a federal estate tax return for the election when the taxable estate as below the Oregon filing threshold of $1,000,000 is a separate cost while filing the federal return for an Oregon estate in excess of $1,000,000 is an incremental cost as federal schedules from the federal 706 return must be included in any event with that Oregon return.

• Size of estate. If the combined estate is between $5,430,000 and $10,860,000, the choice if file for portability is more compelling since appreciation of assets is likely if the life expectancy of the surviving is long or the type of assets are likely to appreciate substantially. Basis step up for income tax savings become important.

18 Bannen, John T. & Occhetti, Kristin A., “The DSUE Coin Flip”, Trusts and Estates, August 2014. 19 Granstaff, Charles A., “Portability + QTIP”, Trusts & Estates, August 2014.



• Choices for Portability20 include:

o Pure Portability – outright to spouse

o Portability Plan – designated in trust for spouse

o Credit Shelter Trust at Death of First Spouse to Die

o Lifetime grantor trusts with variations including the “Supercharged Credit Shelter Trust”21

• Formulas include:

o Disclaimers into traditional credit shelter trusts for Oregon exemptions only, for federal exemption or into a qualified terminable interest property trust (“QTIP” trust) – the later to allow for reverse QTIP elections or other partial elections

o QTIP trust qualified under IRC §2056(b)(7)

o QTIP trust with Clayton provisions for partial elections which provide for directing income to beneficiaries other than the surviving spouse or with “cascading” provisions for layers of exempt trusts

4. Formula Analysis

a. Disclaimer

On the surface, disclaimers appear to be the simplest approach to drafting and, for that reason, they are appealing. However, they can be deceptively complex with many traps for the unwary. The use of disclaimers in estate administrations is governed by I.R.C. §2046 which simply directs one to I.R.C. §2518 for the details. Section 2518 provides that a “qualified disclaimer” treats the interest in property as if it had never been transferred to the person making the disclaimer. The statute outlines the requirements and permits partial disclaimers which afford an opportunity for tax planning if the married couple is comfortable in permitting the surviving spouse to disclaim.

The statute contains a number of parts, each of which can present problems in the application:

“2518(a) General Rule. For purposes of this subtitle, if a person makes a qualified disclaimer with respect to any interest in property, this subtitle shall apply with respect to such interest as if the interest had never been transferred to such person.

20 Zeydel, Portland Estate Planning Counsel Annual Seminar, p. 33. 21 Zeydel, ibid, p. 32 et seq. but beyond the scope of this presentation



2518(b) Qualified Disclaimer Defined. For purposes of subsection (a), the term “qualified disclaimer” means an irrevocable and unqualified refusal by a person to accept an interest in property but only if—

2518(b)(1) such refusal is in writing,

2518(b)(2) such writing is received by the transferor of the interest, his legal representative, or the holder of the legal title to the property to which the interest relates not later than the date which is 9 months after the later of—

2518(b)(2)(A) the day on which the transfer creating the interest in such person is made, or

2518(b)(2)(B) the day on which such person attains age 21,

2518(b)(3) such person has not accepted the interest or any of its benefits, and

2518(b)(4) as a result of such refusal, the interest passes without any direction on the part of the person making the disclaimer and passes either—

2518(b)(4)(A) to the spouse of the decedent, or

2518(b)(4)(B) to a person other than the person making the disclaimer.

2518(c) Other Rules

2518(c)(1) Disclaimer Of Undivided Portion Of Interest

A disclaimer with respect to an undivided portion of an interest which meets the requirements of the preceding sentence shall be treated as a qualified disclaimer of such portion of the interest.

2518(c)(2) Powers

A power with respect to property shall be treated as an interest in such property.

2518(c)(3) Certain Transfers Treated As Disclaimers

A written transfer of the transferor's entire interest in the property—

2518(c)(3)(A)

which meets requirements similar to the requirements of paragraphs (2) and (3) of subsection (b), and

2518(c)(3)(B)



which is to a person or persons who would have received the property had the transferor made a qualified disclaimer (within the meaning of subsection (b)), shall be treated as a qualified disclaimer.”

In the context of planning for marital couples, the goal is to maximize the marital deduction. Thus, the disclaimer will likely be a partial disclaimer limited to the Oregon exemption or possibly equal to the federal basic exclusion amount to fund a credit shelter trust. A partial disclaimer of an undivided portion of an interest in property can qualify but the disclaimed portion needs to be a fraction or percentage of the interest over the complete time of the disclaimant’s interest in the property. The Internal Revenue service disapproves of a disclaimer of a “horizontal interest”. For example, if a decedent gave the surviving spouse a piece of commercial property, the spouse could not retain a life estate and disclaim a remainder interest.

A disclaimer of an undivided portion (but not all) of an interest in property is treated as a qualified disclaimer if it satisfies the requirements of §2518(b).22 The undivided portion of the disclaimant's entire interest must consist of a fraction or percentage of each interest or right of the Disclaimant in the property and must extend over the entire term of the disclaimant's interest in that property and any conversions thereof. The regulations prohibit a “horizontal” disclaimer. Thus, a disclaimer of a remainder interest in a bequest of a fee interest, while retaining a life estate, is not treated as a qualified disclaimer.23

How should the disclaimer of a partial interest be drafted? Here are some approved forms:

• A pecuniary amount based upon a specific amount of tax to be paid in a decedent’s estate24

• A “zero tax” formula25

• A surviving spouse may disclaim a portion that goes into an exemption or bypass trust and still enjoy the income and principal from the trust (subject to an ascertainable standard) although the trust should not contain any power to appoint by the surviving spouse 26

• A fractional disclaimer may be utilized as well. An example for the Oregon Exemption Trust may be used as follows:

“Balance to Surviving Settlor. The balance of such trust property shall be distributed to the surviving Settlor, provided, however, that unless the surviving Settlor directs otherwise in

22 IRC §2518(c)(1). 23 IRC Regs. §25.2518-3(b) and §25.2518-3(d), Ex. (2) 24 PLR 9437029 25 PLR 9435014 26 IRC §2518(b)(4) and 2517(c)(2)



writing, such property shall be added to and disposed of as a part of the trust created under Paragraph (A) of this Article, but provided further, that if the surviving Settlor disclaims all or any portion of the balance of such trust property, such property or portion thereof so disclaimed by the surviving Settlor shall not be made part of such trust created under Paragraph (A) of this Article, and shall instead be held in a separate trust for the benefit of the surviving Settlor during his or her life, as follows:

Oregon Exemption Trust. [provide for terms and conditions of trust]”

The portion disclaimed could be done by a fraction which does not necessarily need to be described in the governing document but could be administered and applied as follows:

The surviving Settlor may disclaim a fraction of the balance of the trust property equal to an amount calculated by a fraction, the numerator of which shall equal the amount of the deceased Settlor’s Oregon Estate tax exemption available under ORS Chapter 118 or it’s then equivalent statute and the denominator shall equal the value of balance of trust property as finally determined for federal estate tax purposes passing to the surviving Settlor under the above paragraph.

b. Qualified Terminable Interest Property Trust (“QTIP”)

The disclaimer approach generally provides an outright marital gift or distribution from the deceased spouse’s trust to the surviving spouse’s revocable trust while giving the surviving spouse a right to disclaim a portion into a disclaimer trust. That approach works reasonably well in long-term marriages with children from the same marriage. In second marriages with children from the previous marriage, spouses will more likely than not will want to avoid the anxiety associated with the question of whether a disclaimer will be made. Instead, a QTIP trust coupled with a portability election will more likely serve the triple objectives of providing for the decedent’s surviving spouse for life, providing an inheritance for the decedent’s children from a prior marriage and achieving a stepped up basis on the couple’s entire estate at the death of the survivor. 27

An election over an appropriate portion of the QTIP trust will qualify that portion for the marital deduction while the decedent’s applicable exclusion can be applied to the unelected portion. Since many estates will fall below the combined applicable exclusions of both spouses, maximizing the marital deduction at the first death may provide a full step up in basis of all of the couple’s assets at the death of the surviving spouse since the elected portion of the QTIP and the survivor’s assets will be included in the survivor’s taxable estate.

27 See IRC §§2010(c), 2056(b)(7) and 2056(b)(10)



Oregon resident decedents of moderate wealth may wish to elect all of the QTIP for a marital deduction with the exception of a sufficient portion to use the $1,000,000 Oregon exemption. That strategy provides up to two Oregon exemptions saving between $100,000 and $160,000 depending upon the Oregon estate tax rate applicable at the surviving spouse’s death.

Partial QTIP elections are permitted and language should be drafted into the estate plan to anticipate their use. Although drafting QTIP marital language for second marriages is often advisable, including QTIP provisions for surviving spouses of first marriages allows time to evaluate the best course of action at the death of the first spouse and to make the QTIP election that yields the best tax outcome.

Self-adjusting formula elections, generally in the form of fractions or percentages28 lead to better tax outcomes as using and reporting a specific fraction or percentage for a partial election can lead to unintended consequences should additional property or previous reported lifetime taxable gifts be discovered after filing the return or should the values be adjusted upon audit. If a specific fraction or percentage is reported and the values of the taxable estate increase or decrease, the elected portion may exceed or fall short of the desired amount. Since the election, once made, is irrevocable, the tax consequences will be set in stone and cannot be changed. 29

An example of this would be where the QTIP trust from the deceased spouse’s estate equals $4,000,000 and the surviving spouse wishes to elect 75% of that amount for a QTIP to maximize the marital deduction and to elect the DSUE of $3,000,000. That unelected portion would equal $1,000,000 and would qualify for the Oregon exemption. If later, the estate values increased to $6,000,000 due to reasons stated above, the 75% election would result in an unelected portion of $1,500,000 [$6M - (75% x $6M )]. That would cause the Oregon estate tax to apply at the first death to $500,000 resulting in a tax of approximately $50,000.

A self-adjusting formula would generally describe the results that the formula is designed to achieve such as setting aside an unelected portion to fund the Oregon exemption trust of $1,000,000. The fraction consists of a numerator equal to the amount exemption desired and a denominator of the portion of the estate to which the fraction is applied, e.g. the “residuary estate”. Where using a QTIP approach, the fraction for the Oregon exemption trust may look like the following:

“Oregon Exemption Trust. A fraction of the QTIP trust, unelected for purposes of the marital deduction, shall fund a subtrust entitled “The Oregon Exemption Trust” calculated as follows: The numerator shall equal the amount of the deceased Settlor’s Oregon Estate tax exemption available under ORS Chapter 118 or it’s then equivalent statute and the denominator shall equal the value of assets in the QTIP trust as finally determined for federal estate tax purposes. The fraction of the QTIP trust so set aside shall be held by the Trustee in the Oregon

28 Regs. §20.2056(b)-7(b)(2)(i) 29 IRC §2056(b)(7)(B)(v).



Exemption Trust as a separate trust for the benefit of the surviving Settlor during his or her life, as follows: [describe terms and conditions of trust].”

Regulations provide examples of acceptable formulas and also permit divisions into separate trusts for the elected and nonelected portions. The divided trusts must be funded on a fractional or percentage basis although it is not necessary to fund each separate trust with a fraction or percentage of each asset30.

Note that the divisions need to be made no later than the end of the estate or trust administration following the decedent’s death. If the division has not been made by the time of filing the federal estate tax return, the intent to make the division must be included on the return. Although the costs of administering separate trusts may increase, accounting and reporting will be easier. The Perhaps more importantly, the chances of achieving desired results from the election or non-election decision is greatly enhanced. By contrast, using a single trust for both elected and non-elected portions requires periodic reappraisals and calculations involving “rolling fractions” to keep accurate records identifying the portions of the trust.31

A “Clayton”32 approach may also be used as a variation of the QTIP approach. An example of the language that can fund a federal exemption trust with targeted elections for Oregon Special Marital Property and a non-elected portion for OSMP purposes within that federal exemption trust equal to the Oregon estate tax exemption follows:

“Division of Decedent’s Share – Clayton. After the payment of the distributions and obligations described in Paragraphs Error! Reference source not found., ___, and ___, the balance of the Decedent’s Share shall be administered pursuant to Paragraph ___ (the “Marital Trust”); provided, however, that any portion of the trust estate for which a marital deduction election for federal estate tax purposes is not made pursuant to Section 2056(b)(7) of the Code, if any, shall be set aside in a separate trust (the “Oregon Special Marital Property Trust”) and shall be applied as provided in Paragraph ___; further provided, however, that any portion of the Oregon Special Marital Property Trust for which an Oregon special marital property election for Oregon estate tax purposes is not made pursuant to ORS 118.013-118.016 shall be set aside in a separate trust (the “Exemption Trust”) and shall be applied as provided in Paragraph ___.

For purposes of the division of the trust estate pursuant to this Paragraph ___, if any, values assigned to all assets shall be those finally determined for federal estate tax purposes.

The Trustee shall have unrestricted discretion to determine which assets or fractional shares of assets shall be allocated to the Oregon Special Marital Property Trust and the Exemption Trust, if any; provided, however, that the

30 Regs. §20.2056(b)-7(h), Exs. 7, 8. 31 Regs. §20.2044-1(e), 32 Estate of Clayton v. Commissioner, 97 TC 327 (1991), rev’d, 976 F. 2d 1486 (5th Cir. 1992)



Trustee shall first allocate to the Oregon Special Marital Property Trust or the Exemption Trust any asset with respect to which a marital deduction for federal estate tax purposes is not allowable due to its character or restrictions associated with it; further provided, however, that the Trustee shall first allocate to the Exemption Trust, to the extent such assets represent a part of the trust estate, any asset with respect to which an Oregon special marital property election is not allowable due to its character or restrictions associated with it; and further provided, however, that allocations of assets to the Oregon Special Marital Property Trust and the Exemption Trust shall be fairly representative of the appreciation and depreciation to the date or dates of each allocation of all the assets available for allocation to such trusts by the Trustee.”

Finally, a QTIP trust offers a great advantage in administering moderately to extremely wealthy estates where full utilization of both spouse’s generation skipping transfer tax exemption is important. Because the GST exemption is not portable as is the DSUE, failure to take advantage of the first spouse’s GST exemption at their death results in only one available GST exemption. By using a QTIP trust, the personal representative or trustee may decide to elect to preserve the deceased spouse’s basic exclusion amount for portability but also to make what is known as a “Reverse QTIP Election”33 which assigns the deceased spouse’s unused GST exemption to the QTIP property even though that property will now be treated as owned by the surviving spouse at his or her death under the Code.34 By assigning the GST exemption of the deceased spouse to a portion of the QTIP elected under this provision, the first GST exemption is not wasted and the surviving spouse’s personal representative or trustee may also apply their GST exemption at the death of the surviving spouse. This combined GST exemption (currently equal to the combined basic exclusion amount of $10,860,000) can be especially valuable to a family business or farming operation where the assets will be maintained without further estate taxes for multiple generations in trusts established in jurisdictions with no rule against perpetuities limitations on trust duration.

Mention of Rev. Proc. 2001-3835 is appropriate as the IRS had addressed the effect of an unnecessary QTIP election which was not needed to reduce the estate tax to zero – a “maximum” marital deduction. Where such an election had been made but turned out to be unnecessary, the Service permitted a surviving spouse’s estate to later reverse or undo the prior election with the effect of excluding the previously elected portion from the surviving spouse’s estate as would have been required under IRC §2044 if the QTIP election had remained in place. This strategy offers some flexibility by, in effect, providing a “second look” to see if using a marital deduction at the first death was most advantageous or not, whereas, an irrevocable portability election must be made at the death of the first spouse to die. There is some speculation that the IRS might limit the scope or use of this election unless the QTIP election was “inadvertent”.36

33 IRC §2652(a)(3) 34 IRC §2044 35 Rev. Proc. 2001-38, 2001-24 I.R.B. 1335 (6/11/2001) 36 Zeydel, Portland Estate Planning Counsel Annual Seminar, p. 29



A full discussion of managing QTIP and Reverse QTIP elected and nonelected trust portions is fascinating but well beyond the scope of this presentation.

2. CASE STUDIES

A. Case Study #1 – Married couple with a $1,000,000 Oregon estate.

This couple is on the cusp of exposure to the Oregon estate tax but has little concern about federal estate tax. Unless values of their assets increase significantly during their lifetimes or the life of the survivor, it is highly unlikely that federal estate tax will ever be a problem. The major planning opportunities would focus on whether or not this couple should consider implementing joint (or separate) revocable living trusts or simply rely upon wills with or without testamentary trusts. That decision primarily involves a decision weighing the costs and time involved with probate compared with a the costs involved in establishing, funding and maintaining lifetime trusts – a decision that may result in using wills and letting their children pick up the probate costs saving the parents the cost of establishing the trusts. Of course, a testamentary trust could be established within the wills for property management for the surviving spouse coupled with a simple disclaimer into a disclaimer trust if saving Oregon estate tax becomes important at the second death.

Although a couple with an estate valued between $1,000,000 and $2,000,000 may be perceived as “wealthy” from the perspective of the Oregon Estate Tax, do they really need a “credit shelter trust” or even an Oregon equivalent to capture the Oregon exemption of $1,000,000? A careful analysis of the economic opportunities and costs associated with establishing trusts and other strategies to minimize estate tax needs to be weighed against the associated cost of establishing, funding and tax filings for a trust.

The following chart shows the increase of the estate at assumed rates of growth from 1-3% which could be looked at as a net after tax and after distribution figure. While there is some exposure to the Oregon estate tax at the second death, it is also probable that the surviving spouse may consume the earnings or growth from the trust during their lifetime. The costs of maintaining a trust and annual tax filings would diminish the growth and work to keep the value relatively stable. Also, allowing the property to pass entirely to the surviving spouse or to the surviving spouse’s revocable living trust permits a step up in basis for the beneficiaries of the surviving spouse. The step up in basis can be achieved with a QTIP trust if an irrevocable trust for the survivor is recommended.



Assume the following facts:

• The surviving spouse lived 15 years and hadn’t consumed any of the growth

• The growth at 2% annually would equal $1,345,868.

• Assume half of the $1,000,000, or $500,000, funded an Oregon exemption trust at the first death.

• The Oregon exemption trust and the surviving spouse’s estate would each have appreciated to $672,934 (one-half of the $1,345,868 total estate) at the second death.

• The children immediately sold the assets after the second death.

• The surviving spouse does not elect portability.

• What are the tax consequences of using an Oregon exemption trust compared with an outright gift of the decedent’s share to the surviving spouse, or in the alternative, in a QTIP trust where a marital election is made?

Combined Gross Assets at First Death 1000000Estimated Asset Growth Rate 0.02

Additional Surviving Years Value of Appreciated AssetsAfter Tax Rate of Return

0.01 0.02 0.030 1,000,000.00 1,000,000.00 1,000,000.00 1 1,010,000.00 1,020,000.00 1,030,000.00 2 1,020,100.00 1,040,400.00 1,060,900.00 3 1,030,301.00 1,061,208.00 1,092,727.00 4 1,040,604.01 1,082,432.16 1,125,508.81 5 1,051,010.05 1,104,080.80 1,159,274.07 6 1,061,520.15 1,126,162.42 1,194,052.30 7 1,072,135.35 1,148,685.67 1,229,873.87 8 1,082,856.71 1,171,659.38 1,266,770.08 9 1,093,685.27 1,195,092.57 1,304,773.18

10 1,104,622.13 1,218,994.42 1,343,916.38 11 1,115,668.35 1,243,374.31 1,384,233.87 12 1,126,825.03 1,268,241.79 1,425,760.89 13 1,138,093.28 1,293,606.63 1,468,533.71 14 1,149,474.21 1,319,478.76 1,512,589.72 15 1,160,968.96 1,345,868.34 1,557,967.42



USING AN OREGON EXEMPTION TRUST

Value of assets at second death with 2% annual appreciation

Basis Gain Oregon Estate Tax

Capital Gains @ 30%/28%

Oregon Exemption Trust

672,934 500,000 172,934 0 51,880/ 48,422

Survivor’s Estate

672,934 672,934 0 0 0

FORGOING AN OREGON EXEMPTION TRUST

Survivor’s Estate

$1,345,868 1,345,868 0 $34,586 0

It appears that conventional planning that mandated an Oregon exemption trust would create capital gain taxes exceeding the Oregon estate tax by $17,294 with the 3.8% surtax applying or $13,836 without the 3.8% surtax applying ($51,880 – 34,586; $48,422 – 34,586). In addition, trust maintenance costs including trustee fees, accounting and tax reporting fees and legal fees must be considered as an additional cost of maintaining the Oregon exemption trust for an estate at this level of wealth

B. Case Study #2 – Married couple with a $2,000,000 Oregon estate.

Look at the possible outcomes with the following assumptions:

• Same 2% annual appreciation as in Case Study #1

• Oregon Exemption Trust of $1,000,000 at first death and survivor’s keeps $1,000,000.

• 15 years between first and second deaths.

• Children sell all assets after the death of the surviving parent.



USING AN OREGON EXEMPTION TRUST

Value of assets at second death with appreciation

Basis Gain Oregon Estate Tax

Capital Gains @ 30%

Oregon Exemption Trust

$1,345,868 1,000,000 345,868 0 $103,760

Survivor’s Estate

$1,345,868 $1,345,868 0 $35,00037 0

FORGOING AN OREGON EXEMPTION TRUST

Survivor’s Estate

$2,691,737 $2,691,737 0 $172,153

0

Sale of assets with OR Exp Trust + SS’s Estate

$138,760 = + 35,000 +103,760

Sale of assets without OR Exp Trust + SS’s Estate

Difference: $33,393 Additional tax

$172,153

It appears from this simple example that capital gain taxes on the sale of assets

distributed from the Oregon exemption trust combined with Oregon estate taxes on the survivor’s estate total $138,760 but forgoing an Oregon exemption trust increases Oregon estate tax to $172,153). This example favors using the Oregon exemption trust. Several approaches would provide this outcome for the children of the parents:

• The decedent’s estate passed outright to the surviving spouse and the spouse disclaims into an Oregon exemption trust.

• The decedent’s estate passes into a QTIP trust and a QTIP election was made for the surviving spouse in excess of the Oregon exemption.

• The decedent’s estate passes to a QTIP trust and a QTIP election was made for the surviving spouse over the Oregon exemption and portability was elected (to hedge against loss of the DSUE).

• The decedent’s estate passed to a general appointment marital trust for the surviving spouse in excess of the Oregon exemption.

37 Rounded



Since the estate of the deceased spouse to die first exceeded the Oregon filing threshold for filing an OR 706 and the instructions require filing federal schedules with the Oregon return, it seems that it will be a small incremental cost for surviving spouses in this circumstance to file for portability to use the DSUE.

C. Case Study #3 – The Oregon $7,000,000 estate.

Obviously, this “moderately wealthy” couple will experience both Oregon and federal estate tax on the death of the survivor absent further planning or steps taken at the first death. A graphic illustration shows the importance of addressing portability planning since the combined estates could equal almost $15,000,000 at 5% appreciation and almost $33,500,000 at 8% appreciation. Portability will provide federal estate tax savings at 5% and 8% appreciation if the surviving spouse survives the deceased spouse by 10 years and 5 years respectively. To save further estate tax beyond what portability will provide, the plan would need to consider additional strategies outside of this presentation.

In this example, the personal representative may very well elect portability at the death of the first spouse to die. Therefore, the estate plan should anticipate that alternative in the governing documents. Methods to achieve portability involve the following approaches:

• Outright to surviving spouse

• Distribute decedent’s share in trust to surviving spouse’s revocable trust portion

• Distribute decedent’s share to a general appointment marital trust for surviving spouse

$-

$5,000,000

$10,000,000

$15,000,000

$20,000,000

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$30,000,000

$35,000,000

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0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

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Surviving Spouse Life Expectancy

5% 8% 11% Surviving Spouse's Exemption Combined Exemption



• Permit a disclaimer to create an Oregon exemption trust of $1,000,000 at the first death to save on Oregon estate tax at the death of the survivor (worth $100,000 to $160,000 alone on the OET rates of 10-16% as well as on the appreciation in the Oregon exemption trust).

• Provide a QTIP trust for the surviving spouse with election strategies at the death of the first spouse as follows:

o QTIP election – for all or for the portion in excess of the $1,000,000 Oregon exemption

o Reverse QTIP election – to preserve the deceased spouse’s GST exemption (generation skipping transfer tax) which is not allowed to be ported over to the survivor on a portability election

o Fractional or pecuniary? (see prior discussion in 3.D above)

How much wealth can be transferred in this scenario if maximizing wealth transfer is the key driver? The following chart and graph illustrates the wealth transfer under 3 scenarios which look at portability and a credit shelter trust for one-half of the estate and no other planning:

• 100% marital deduction with portability ($18,439,110)

• Funding a bypass trust equal to one-half of the estate $3,500,000 ($7M/2) with the sale of 100% of the assets at the second death ($19,199,369)

• Funding a bypass trust equal to one-half of the estate $3,500,000 ($7M/2) with never selling the assets (could be important with family businesses, farm or ranch property or other “legacy” assets) ($21,480,147)



Graphically, this can be illustrated37 as follows:

3737 The Portability Calculator, Keebler Tax, Financial and Wealth Software, Inc., d/b/a Keebler Software (2014)

Total Wealth TransferPortability Bypass Trust

Additional Surviving Years 100% Liquidation at Second Death No Liquidation

0 2015 7,000,000 7,000,000 7,000,000 1 2016 7,560,000 7,476,000 7,560,000 2 2017 8,164,800 7,990,080 8,164,800 3 2018 8,817,984 8,545,286 8,817,984 4 2019 9,523,423 9,144,909 9,523,423 5 2020 10,285,297 9,792,502 10,285,297 6 2021 11,108,120 10,491,902 11,108,120 7 2022 11,882,062 11,247,254 11,996,770 8 2023 12,509,907 12,063,035 12,956,511 9 2024 13,183,819 12,944,078 13,993,032

10 2025 13,907,485 13,895,604 15,112,475 11 2026 14,684,884 14,923,252 16,321,473 12 2027 15,524,314 16,033,112 17,627,191 13 2028 16,426,420 17,028,288 18,833,893 14 2029 17,396,213 18,074,231 20,108,284 15 2030 18,439,110 19,199,369 21,480,147

$5,500,000

$7,500,000

$9,500,000

$11,500,000

$13,500,000

$15,500,000

$17,500,000

$19,500,000

$21,500,000

$23,500,000

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

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Portability100% Liquidation at Second DeathNo Liquidation



D. Case Study #4 – The Oregon $11,000,000 estate.

This couple is on the higher end of “moderate” wealth and will very likely need more planning than that which can come from pure portability as the beneficiary’s inheritance will be subject to substantial Oregon and federal estate taxes on the death of the surviving parent. A graphic illustration shows the importance of addressing portability planning since the combined estates could equal almost $23,000,000 at 5% appreciation and almost $35,000,000 at 8% appreciation. Portability alone will provide federal estate tax savings if the surviving spouse survives dies within just 1-3 years of the deceased spouse. Planning for this couple cries out for techniques that do not use their federal exemptions and that remove assets out of their Oregon estates. These techniques might include Grantor Retained Annuity Trusts (“GRATs”)38 or sales to Intentionally Defective Grantor Trusts (“IDGTs”)39 that use very little of the basic exclusion amount and preserve the DSUE. Should the surviving spouse decide to use the DSUE for lifetime gifts, shifting growth on rapidly appreciating assets can effectively remove the increase from the taxable estate. The carryover basis problem can be addressed by using a grantor trust and swapping high basis assets (such as cash) for the appreciated assets in the trust, allowing a “stepped up basis” without inclusion in the surviving spouse’s estate at death.40 Many other strategies, beyond the scope of this presentation, can be employed during the lives of the spouses.

38 I.R.C. §2702, §7520, Reg. §20.2036-1(c)(2), §25.2702-2, §25.2702-3; Walton v. Commissioner, 115 T.C. 589 (2000)); Notice 2003-72, 2003-44 I.R.B. 964 (announcing IRS acquiescence in Walton) 39 Rev.Rul.85-13, 1985-1 C.B. 184 40 See J. Blattmachr, M. Gans & H. Jacobson “Income Tax Effects of Termination of Grantor Trust Status by Reason of the Grantor’s Death, “ 97 JTAX 149 (September 2002)

$-

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0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

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5% 8% 11% Surviving Spouse's Exemption Combined Exemption



How much wealth can be transferred in this scenario if maximizing wealth transfer is the key driver? The following chart and graph illustrates the wealth transfer under 3 scenarios which look at portability and a credit shelter trust for one-half of the estate and no other planning:

• 100% marital deduction with portability ($26,052,316)

• Funding a bypass trust equal to one-half of the estate $5,500,000 ($11M/2) with the sale of 100% of the assets at the second death ($26,762,615)

• Funding a bypass trust equal to one-half of the estate $5,500,000 ($11M/2) with never selling the assets (could be important with family businesses, farm or ranch property or other “legacy” assets) ($30,787,645)

Additional Surviving Years Value of Appreciated AssetsAfter Tax Rate of Return

5% 8% 11%-$ 11,000,000$ 11000000 11000000

1$ 11,550,000$ 11880000 122100002$ 12,127,500$ 12830400 135531003$ 12,733,875$ 13856832 150439414$ 13,370,569$ 14965378.56 16698774.515$ 14,039,097$ 16162608.84 18535639.716$ 14,741,052$ 17455617.55 20574560.077$ 15,478,105$ 18852066.96 22837761.688$ 16,252,010$ 20360232.31 25349915.479$ 17,064,610$ 21989050.9 28138406.17

10$ 17,917,841$ 23748174.97 31233630.8511$ 18,813,733$ 25648028.97 34669330.2412$ 19,754,420$ 27699871.29 38482956.5713$ 20,742,141$ 29915860.99 42716081.7914$ 21,779,248$ 32309129.87 47414850.7915$ 22,868,210$ 34893860.26 52630484.37



Graphically, this can be illustrated as follows:

0 2015 10,960,000$ 10,960,000$ 10,960,000$ 1 2016 11,532,000$ 11,558,160$ 11,706,400$ 2 2017 12,146,240$ 12,200,653$ 12,508,992$ 3 2018 12,806,099$ 12,891,025$ 13,372,271$ 4 2019 13,519,227$ 13,637,107$ 14,305,093$ 5 2020 14,285,565$ 14,439,036$ 15,308,701$ 6 2021 15,109,371$ 15,301,278$ 16,388,757$ 7 2022 15,995,240$ 16,228,661$ 17,551,377$ 8 2023 16,952,139$ 17,230,394$ 18,807,167$ 9 2024 17,981,431$ 18,308,105$ 20,159,261$ 10 2025 19,088,905$ 19,467,873$ 21,615,361$ 11 2026 20,280,817$ 20,716,263$ 23,183,790$ 12 2027 21,567,923$ 22,064,364$ 24,877,534$ 13 2028 22,953,517$ 23,515,834$ 26,702,296$ 14 2029 24,445,478$ 25,078,940$ 28,668,560$ 15 2030 26,052,316$ 26,762,615$ 30,787,645$

Additional Surviving Years

100% Liquidation at Second Death

No Liquidation

Total Wealth Transfer

PortabilityBypass Trust

$5,500,000

$10,500,000

$15,500,000

$20,500,000

$25,500,000

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$35,500,000

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

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Portability

100% Liquidation at Second Death

No Liquidation



In conclusion, much has changed in the last three to five years that has impacted the estate planning practice. Most particularly, existing plans of many clients that were based upon previous strategies designed to optimize rather than maximize the marital deduction will benefit from a fresh view. These changes offer challenges and major opportunities to reconnect with our clients and to offer valuable updates to their plans that will introduce flexibility and sometimes simplicity to achieve improved outcomes for their heirs and beneficiaries.





Chapter 5

From Elementary and Effective to Hot and Sophisticated: 30 Great Ideas in 60 Minutes

Stephen lane

Gleaves Swearingen LLPEugene, Oregon

Contents

Disclaimer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–1

Elementary and Effective Ideas. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–1

Tricks and Traps with Tax-Favored Accounts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–4

Planning Turned Upside Down; Income Tax Basis and Transfer Taxes . . . . . . . . . . . . . . . . . 5–6

Trusts for All Seasons and Reasons . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–8

Ideas from All Over . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–12

Special Lessons from the Past. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–14

Form 2—Residential Trust Agreement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–15

Form 4—Amendment to Revocable Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–17

Form 5—Client Status Language. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–19

Exhibit 14—Roth Conversion Checklist . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–21

Form 17—Qualified Retirement Plan and IRA Benefits Language . . . . . . . . . . . . . . . . . . . 5–23

Form 25—Amendment to LLC Operating Agreement. . . . . . . . . . . . . . . . . . . . . . . . . . 5–25

Exhibit 27—Spousal Exemption Cake Trust or Spousal Annual Exclusion—Created by Husband and Wife Avoiding the Reciprocal Trust Doctrine . . . . . . . . . . . . . . . . . . . . . . 5–27

Form 28—Stock Gift and Sale Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–29

Exhibit 35—Form OR706-A, Oregon Additional Estate Transfer Tax Return . . . . . . . . . . . . . 5–33

Exhibit 37A—Estate Planning Associate Training Curriculum and Projects Checklist. . . . . . . . 5–39

Exhibit 37B—Estate Planning and Administration Legal Assistant Checklist. . . . . . . . . . . . . 5–43

Exhibit 38—To Expand on the Admonition of Earl Long . . . (Handout from Conclusion of Presentation) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–47

Chapter 5—From Elementary and Effective to Hot and Sophisticated: 30 Great Ideas in 60 Minutes




30 GREAT IDEAS IN 60 MINUTES

DISCLAIMER

The seminar materials and presentation provided here are intended to stimulate thought and discussion, and to provide those attending with useful ideas in the areas of estate planning and administration. The materials and the comments made by the presenter do not constitute and should not be treated as legal advice regarding the use of any particular estate planning technique, device or strategy. These materials are intended to provide only a cursory overview of the complex concepts addressed. Each person utilizing these materials should verify the efficacy of each concept before applying them to a particular fact pattern and should determine independently the tax and other consequences of using any particular device, technique or strategy before considering recommending the same to a client or implementing the same on a client’s or his or her own behalf. If any materials make use of copyrighted or proprietary writings or concepts the use was unintentional or intended as “fair use” in furtherance of this presentation’s purpose.

ELEMENTARY AND EFFECTIVE IDEAS

1. POD AND TOD TO AVOID PROBATE; TOD FOR NON-MARKETABLE ASSETS. We are all familiar with the technique of POD or TOD designations for bank accounts and brokerage accounts. POD and TOD designations, coupled with other beneficiary designations, can often accommodate most if not all of the client’s testamentary intentions. One thing to remember is that heirs and beneficiaries will consider themselves entitled to the proceeds (as they are) but that does not negate their responsibility to report and pay estate taxes if necessary. Often overlooked is the ability to make TOD designations with respect to closely held business interests such as law firm partnership or shareholder interests, family investment LLC interests, and other private equity holdings. It may be necessary to modify governing instruments to accommodate a TOD designation, but it can often greatly simply the transfer of business interests.

2. ONE PAGE REVOCABLE TRUST FOR THE HOME. If you have made needed TOD, POD and beneficiary designations successfully, there still may be a probate asset that is not addressed by a beneficiary designation. Often this is the family home. While we now have a “transfer on death deed” (ORS 93.948 to 93.985), not all practitioners are comfortable with that arrangement. A fairly simply way to address the remaining real estate interest is a one page (almost) trust just for the principal residence. (See Form 2).



3. DON’T PROVIDE ANALYSIS OR OPINION ABOUT LIFE INSURANCE. Many of the ILITs formulated twenty to thirty years ago have underperformed the non-guaranteed projections which were the basis of the planning if the first place. Life insurance by its very nature is fraught with complexity. If you are involved in an estate plan implementing life insurance planning, be sure to disclaim any knowledge or responsibility about the economic results of the product. That is up to the client and the insurance advisor.

4. MAKE CHILD CO-TRUSTEE AND NOT JUST SUCCESSOR TRUSTEE. All of our revocable trusts provide for a successor trustee if the original grantor ceases to serve because of death or incapacity. Death is easy to establish. Incapacity is not easy to establish. In order to avoid the complexity of demonstrating incapacity make the trusted successor trustee a current co-trustee with full authority to act solely as the trustee under the trust agreement. (See Form 4).

5. INCLUDE AGENT AUTHORITY TO ACT AS CLIENT WITH PRINCIPAL’S LAWYER IN DURABLE POWER OF ATTORNEY. Our clients can act through agents. The transition of the elderly from competent to incompetent can occur at an excruciatingly slow pace and you, the trusted attorney, may not know when the client is actually capable of continuing to maintain the attorney-client relationship. Some day you will receive the phone call from your client’s child saying “Mom is going to a nursing home because she cannot manage for herself” and asking you “Are all the necessary legal arrangements in place?” Your first reaction is that you cannot discuss attorney-client matters with a third party without authorization from the client. It also may be uncertain whether the client can give you that consent currently. Include the authority of the agent to act in the attorney-client relationship capacity in the Durable Power of Attorney. (See Form 5).

6. DON’T LEAVE BEQUEST TO CHARITY IF CHILDREN ARE TRUSTED TO MAKE THE GIFT. Many clients want to leave a modest but meaningful amount to their favorite charities when they die. That is always very nice, but means the family foregoes the income tax deduction. If the client is comfortable with the arrangement, and there are no estate taxes to be saved, consider a handshake deal where the children will turn around and make the charitable contribution after the parents’ deaths and derive the benefit of the income tax deduction.



7. BESSEMER TRUST COMPANY WEB SITE. Bessemer Trust Company, headquartered in New York, provides the best free current insights into sophisticated estate planning topics. This is because they hired Steve Akers who publishes on the Bessemer website his ongoing commentary from such events as the ACTEC Annual Meeting, the Heckerling Institute, and analyzes significant current estate tax cases. Steve’s commentary and insights are invaluable to practitioners. All you need to do is sign up, for free, for access to the site (bessemertrust.com).

8. AVOID MULTIPLE FIDUCIARIES IF POSSIBLE. Parents often wish to name all or many of their offspring as successor fiduciaries so nobody feels left out. If there are frictions already present in the sibling relationships, you are often better not to use one of the offspring as successor fiduciary anyway. If the children in fact get along, and there is one with clearly superior capabilities, or a better geographic location, naming a single fiduciary and seeing that they keep everyone informed is much easier than dealing with multiple personal representatives or trustees.

9. DISCUSS LACK OF PENALTY FOR FAILURE TO FILE OREGON 706 IF NO TAX DUE. If you have an Oregon only estate which will not owe any Oregon estate tax, but exceeds the $1,000,000 filing threshold, do you have to file the return? There is no penalty for failure to file the return if no tax is due. You should explain to the client that they will not get the benefit of a statute of limitations expiring on the Oregon estate, but you might also mention the number of DOR agents who manage the Oregon estate tax.

10. AVOID NON-QUALIFIED ANNUITIES; CASH OUT WHILE ALIVE IF ESTATE IS TAXABLE. Nonqualified commercial annuities, often sold to elderly persons looking for a “enhanced return,” carry nothing but income tax headaches, particularly for surviving beneficiaries. The unrealized income is IRD taxed at ordinary income tax rates to the recipients with no benefit from the IRC §1014 basis step up. I have never met beneficiaries who were happy that their deceased parent invested in nonqualified annuities which they inherited.

11. MOVE THE ESTATE OUT OF OREGON BY PURCHASING TANGIBLE PERSONAL PROPERTY IN ANOTHER STATE. The Oregon estate tax applies to the intangible personal property of Oregon residents as well as the real and personal property located in Oregon of residents and nonresidents alike. Note that tangible personal property is subject to the estate tax based on its situs.



Consider a wealthy Oregon resident purchasing tangible personal property located in California or Nevada which the Oregon resident owns at death. Items such as artwork, collectible automobiles, and possibly bullion, could be effective receptacles for an Oregon resident’s wealth in a location beyond the application of the Oregon estate tax.

TRICKS AND TRAPS WITH TAX FAVORED ACCOUNTS

12. DON’T DO ANYTHING UNTIL YOU READ LIFE AND DEATH PLANNING FOR RETIREMENT BENEFITS BY NATALIE B. CHOATE. Do not enter the minefield of estate planning with qualified plan and IRA assets without consulting Life and Death Planning for Retirement Benefits, Natalie B. Choate, 7th Edition, 2011. Go to ataxplan.com and order for $89.95. The February 17, 2015 Post-Publication Updates can be downloaded as a pdf file for free. If you want to ignore Idea 18 below, read Making Retirement Benefits Payable To Trusts, Natalie B. Choate, also available at ataxplan.com for $39.95 and also presented at a recent CLE meeting in Oregon (Eugene, November 14, 2014). Another good resource is How to Draft Trusts to Own Retirement Benefits, Keith A. Herman, ACTEC Law Journal, Winter 2013, Vol. 39, pg. 207.

13. ROTH IRA FOR CHILDREN WITH EARNED INCOME. Wealthy parents should be sure that their children with earned income, if their AGI meets the limitation test, invest annually in a Roth IRA. That contribution should be made at the beginning of the year and not later. Parents should make cash gifts if needed to make this planning palatable to the children.

14. DEATHBED ROTH CONVERSION. The Roth IRA is a powerful tool for income tax minimization and wealth transmission. As long as we have the “stretch out” rules available to us, a child inheriting a Roth account has an opportunity to realize substantial nontaxable income over the recipient’s life expectancy period. In addition, wringing the income tax out of an otherwise taxable IRA reduces both the federal and state death tax. Yes, there is an income tax deduction associated with paying estate tax on items of IRD (IRC §691), but that is a generally cumbersome process to implement, and there is no corresponding provision with respect to Oregon estate tax paid with respect to the IRD items. (See Checklist Form 14).

15. CHARITABLE GIFTS WITH TAXABLE IRA ACCOUNTS. Testamentary charitable gifts are best made with taxable IRA or retirement plan accounts. It simply means that you are using the cheapest dollars, in terms of the



inheritance of family members, in funding the charitable gift. (See Nathalie Choates Treatise described above).

16. CONTROLLING THE BENEFICIARY WITH A TRUSTEED IRA. Much has been written about the metaphysics of passing qualified plan for IRA benefits into or through a trust. That situation presupposes that you have a beneficiary whose economic interests need to be under the control of someone else. While most IRAs are maintained by financial institutions as custodial accounts, subject to the direct control of the beneficiary, there is a second species of IRA called “a trusteed IRA.” These are offered by national banks and formulate all of the IRA rules under a trustee arrangement where the discretion of the beneficiary as to investments or as to distributions, can be vested in the trustee. While the conduit rules will be applied (discussed below), the trusteed IRA can be an effective arrangement to regulate the economic benefit going to the beneficiary of the IRA death benefit.

17. CONDUIT TRUST AS A SAFE HARBOR. The safe harbor for using an IRA coupled with a trust for a beneficiary, is to provide for conduit treatment. This means that the required minimum distributions will be directly distributed by the trustee to the beneficiary and therefore the beneficiary is treated as the measuring life for the spread out. (See Form 17).

18. SO YOU STILL WANT AN ACCUMULATION TRUST FOR THE IRA OR RETIREMENT PLAN BENEFIT? DON’T DO IT!

19. 529 PLAN FOR ADULT CHILDREN. 529 College Savings Plans have been in the news lately. President Obama floated the idea of limiting the 529 arrangement because, in his view, it is overwhelmingly slanted towards the wealthy. Of course he is right. In fact he is so right, he and Michelle contributed $240,000 to a 529 College Savings Plan for their daughters. The 529 account is the only species of property interest which can qualify as a completed gift, front load five years of annual exclusion gifts, remain under the investment and distribution control of the donor, be excluded from the assets of the donor for creditor claim purposes, and still not be an asset of the donor’s estate for estate tax purposes. So what do you do when the kids are out of college but have not started families of their own? Consider a front loaded 529 College Savings Plan for an adult child and, when grandchildren come along, change the beneficiary from the child to the grandchild. There are no income tax consequences. However, the child is treated as making a taxable gift (not eligible for the annual exclusion) when the beneficiary is shifted to a



lower generation. So what? You have simply used some of the child’s ever-increasing unified exemption, the child files a gift tax return, and you have prefunded a tax favored account to meet future educational needs of the family.

20. BEQUEST TO 529 PLAN ACCOUNT. Can a bequest be made to a 529 College Savings Plan? There is no commentary on that matter but there is no reason you could not. Remember each state has a “maximum” account amount after which no additional contributions can be made. That number is usually in the $300,000 range. So a bequest to a 529 College Savings Plan, on behalf of a grandchild, with the child as the owner and the grandchild as the beneficiary, might be made in a single payment of the full maximum contribution amount.

21. HOW MUCH CAN BE PUT IN 529 PLANS? We just discussed that each state has a ceiling beyond which no additional contributions can be made. There is no coordination of these limitations among the states. In other words, conceivably you could have a 529 in each of 50 states, with each maxed out in the range of $300,000.

PLANNING TURNED UPSIDE DOWN; INCOME TAX BASIS AND TRANSFER TAXES

22. DEFUND THE ESTATE OF THE SURVIVING SPOUSE FOR OREGON TAX; DEATHBED MARGIN LOAN AND GIFTS. The Oregon estate tax can be reduced by lifetime gifts, including those made shortly before the time of death. However, preservation of stepped up basis for appreciated assets with build in gain can make the estate tax savings meaningless. A client with substantially appreciated marketable securities, typically held in a brokerage account, should consider taking out a margin loan shortly before death. The proceeds of the margin loan can be used to make intervivos gifts, defunding the Oregon taxable estate, and after death those assets can be liquidated with little or no recognition of gain. Of course the proceeds are then used to pay off the margin loan. Be careful to ensure that the client has personal liability (recourse) on the loan so that the obligation is a personal liability of the decedent and therefore a debt deducted in determining the taxable estate.

23. GIVE LOW BASIS ASSETS TO DYING SPOUSE; ESTABLISH BYPASS TRUST FOR SURVIVING SPOUSE WITH H.E.S.M. IRC §1014(e) negates basis step up at death if property is acquired from a decedent and, within the one year period prior to the date of death, the recipient of that property had transferred the same property to the decedent. If low basis property was transferred by



gift to the decedent from the surviving spouse, and instead of the property passing back to the surviving spouse the property funds a bypass trust, does this constitute having the property “be acquired from the decedent?” PLR 9321050 implies that a property interest reverting to the original donor spouse in the form of an income interest causes the actuarial value of the income interest to be the “property” being returned to the original donor. If the bypass trust instead provides only for the discretionary distributions under H.E.S.M., there is a good argument that the property will receive a 100% basis step up.

24. LEAVE $1 MILLION TO CHILDREN AT THE FIRST DEATH (USING LOW BASIS ASSETS). With the huge spread between the federal estate tax exemption and the Oregon estate tax exemption, many clients do bypass trust tax planning only for the purpose of preserving the first decedent’s Oregon exemption amount. This ends up with a $1,000,000 bypass trust and the balance of the estate passing to the surviving spouse. If there are plenty of assets to take care of the surviving spouse, why not leave the $1,000,000 exemption amount directly to the children at the first death? In addition, this $1,000,000 gift to the children can be orchestrated to utilize appreciated assets that receive a basis step up at the death of the first spouse.

25. UNDO LLC, PARTNERSHIP AND S-CORPORATION DISCOUNTS. Much of our valuation (“discounts”) planning was put in place when the United States estate tax exemption amount was in the $1,000,000 range. Now, with the combined exemptions of husband and wife approaching $11,000,000, basis step up can be much more valuable than estate tax minimization (but always keeping in mind the Oregon estate tax exemption amount). Current governing documents for business and investment entities should be reviewed in light of negating the discount planning we put in place before. Consider giving each owner (or each owner with a certain threshold amount of equity) a put option at liquidation value or an option to cause dissolution of the entity during lifetime. (See Form 25). Note that for farmers and ranchers with estates in the $5,000,000 to $10,000,000 range, the Oregon Natural Resources Credit is likely to eliminate Oregon estate taxes if planned correctly. This is a category of client which should give careful attention to modifying organizational documents to negate discount planning and instead optimize basis step up.

26. DIVISIVE REORGANIZATION FOR LLC WITH HIGH BASIS AND LOW BASIS ASSETS; MAKE THE 754 ELECTION FOR LOW BASIS LLC. Paul S. Lee of Bernstein Global Wealth has an excellent presentation regarding the simultaneous equation analysis of transfer tax minimization versus basis step up



maximization. One idea Paul shares in his presentation is pre-death planning with business interests which are taxed as partnerships. Typically this will be an LLC. Paul notes that the 754 election is an all or nothing concept with respect to each entity taxed as a partnership. Paul points out that there may be appreciated assets as well as depreciated assets in a family investment company LLC and therefore making the 754 election can be either detrimental or beneficial depending upon the asset mix. Paul suggests that, in planning for the passing of one or more LLC members, a divisive reorganization be considered. That reorganization would create two mirror image LLC’s out of the original LLC but with the target appreciated assets in one of the resulting LLC’s and the non-appreciated or loss assets in another. This way, post-death, the entity with the appreciated assets can make the 754 election.

TRUSTS FOR ALL SEASONS AND REASONS

27. THE ALL IN ONE TRUST THAT DOES EVERYTHING. In 2012 the great uncertainty over “Sunset” spurred many wealthy clients to make large gifts in the $5,000,000 zone. In order to cushion the shock of parting with large amounts of wealth, clever planners devised the equivalent of an intervivos credit exemption bypass trust with the donor’s spouse as trustee, withdrawal rights under “H.E.S.M.”, and possibly a mandatory income interest and limited power of appointment granted to the trustee spouse. From this beginning a plethora of articles began describing a variety of multi-faceted intervivos trusts with lots of catchy titles. Some of the nomenclature: Rainy Day Trust, Swiss Army Knife Trust, Spousal Limited Access Trust (“SLAT”), Spousal and Family Exemption Trust (“SAFE” Trust), Supercharged Credit Shelter Trust (service mark of Prof. Mitchell M. Gans, Diana S.C. Zeydel and, of course, Jonathan G. Blattmachr). My personal favorite is “Cake Trust” (have it and eat it too; and I have not registered a service mark). So what features can we include? What should this trust be and not be? What it can be:

• A trust controlled by the grantor’s spouse during his or her lifetime. • An income tax “defective” grantor trust to the donor spouse. • An intervivos credit shelter trust. • A limited spousal access trust. • A generation skipping (zero inclusion ratio) trust. • An asset protection trust as to beneficiaries. • A trust with beneficiaries who are trustees in control.



• A charitable trust coupled with a donor advised fund.

What it should not be: • An irrevocable life insurance trust. • A crummey (withdrawal) annual exclusion trust. • A reciprocal trust. • A QTIP trust.

So now we need a name and I’ll use “Universal Trust.” The Universal Trust can be the central vehicle for wealth value freezing and transmission. There can be two Universal Trusts, each established by one of the spouses so long as the trusts are not “reciprocal.” (See Form 27). The leveraging provided by grantor trust status is still good law until a “comprehensive” overhaul of the IRC occurs. I use two defects. First, the asset swap power held in a non-fiduciary capacity by the grantor (IRC §675(4)(c)). See Rev. Rul 2008-22, PLR 9504024 and 200434012. The second defect is the power to add to a class of beneficiaries, for instance charities, held by a non-adverse (disinterested) party (IRC §674(a)). I provide that both powers can be waived and if both are in fact waived, grantor trust status ends. I do not have the courage to include a “toggle on” feature. Properly structured the Universal Trust is: (1) receiving gifts within the unified exemption generating no gift tax; (2) excluded from the grantor’s estate; (3) exempt from generation skipping tax within the constraints (or lack of constraints) of the Rule Against Perpetuities; (4) income taxed to the grantor during his or her life as long as the “defects” are not waived; (5) to which the grantor can sell assets without triggering gain; and (6) which can enter into “Wandry” type transactions (discussed below) without the income tax uncertainty of splitting entity ownership among taxpayers during the open gift tax statute of limitations. Maybe the frosting on the Universal (Cake) Trust is utilization of the swap power by a grantor with a short life expectancy. If the Universal Trust has low basis appreciated assets swapped by the grantor for cash of equivalent value, a significant basis step up can be achieved with no income tax consequences from the transaction (Rev. Rul. 85-13). Some commentators have toyed with the idea that the trustee (non-donor) spouse could be granted and exercise a limited power of appointment to create an overlife life estate for the original donor spouse if the donor is the surviving spouse. Professor Jeffrey N. Pennell points out this would cause inclusion in the original donor



spouse’s estate (defeating the planning purpose) because of the common law principle that a nongeneral power of appointment is treated as if the power holder were the donor’s agent and that the exercise relates back to the trust inception. Thus the donor would be treated as having retained beneficial interest under IRC §2036(a)(1).

28. GIFT AND SALE OF HARD TO VALUE ASSETS TO THE GRANTOR TRUST USING WANDRY TYPE FORMULA. Wandry v. Commissioner, TCM 2012-88 (3/26/12) has energized the use of “defined value clauses” in intervivos estate planning. Being blessed to practice in the 9th Circuit we also have Petter v. Commissioner, TCM 2009-280, affirmed 653 F.3d 1012 (9th Cir. 2011). Some use these formulas only coupled with a charitable interest. Others see the clear acceptance of defined value formula clauses in the testamentary context (Rev. Proc. 64-19, and GST Treas. Reg. §26.2632-1(6)(2)(ii) and -1(d)(1)) as a policy position the IRS should follow consistently. If a gift formula can be defined in terms of assets with a specific dollar value as finally determined for United States Gift Tax purposes, can the excess assets over the gift amount be sold to the same donee trust at the same final value? Yes. The result is a fixed number of units, shares, etc. of a closely held entity being transferred to the income tax grantor trust, with a portion being a defined value gift and the rest as a sale to the same grantor trust. (See Form 28). For a comprehensive outline see Ronald D. Aurutt, Grantor Retained Annuity Trusts (GRAT) and Installment Sales to Grantor Trusts, at the mcguirewoods.com website. These initial Wandry transactions were reported on 2012 gift tax returns filed starting April 15, 2013. We are now in the third year of the gift tax statute of limitations. Question: If the IRS does not challenge the gift value reported, can it still challenge the sale portion as a bargain sale gift equivalent? This would depend on whether the sale component was disclosed on the gift tax return. Now for the cautions:

• The IRS is far from pleased by this strategy and the leverage provided by the sale to a grantor trust. The Tax Court docketed Estate of Marion Woelbing v. Commissioner, Docket No. 30260-13, discloses the IRS frontal assault based on the assertion that the note taken back by the grantor as consideration for the sale is a sham, that the note has zero value, therefore the transfer was a gift



transfer “for less than adequate consideration.” Other theories of the IRS are that the transfer is not a “bona fide transaction” (therefore ignored for estate tax purposes) and that IRC §2702 applies for estate tax purposes because the note has zero value. See Steve R. Akers’ article, Sale to Grantor Trust Transaction (Including Note With Defined Value Feature) Under Attack, Estate of Donald Woelbing v. Commissioner (Docket No. 30261-13) and Estate of Marion Woelbing v. Commissioner (Docket No. 30260-13), February 4, 2014. A good update appears in BNA Weekly Report, 3/23/15, IRS Challenge to Installment Sales With Grantor Trusts Fuels Concerns Over Strategy, authored by Diane Freda. An important lesson is to make the sale transaction as “bona fide” as possible.

• The purchasing grantor trust must have economic substance to make it capable of servicing its debt to the grantor. A 10% equity cushion is generally regarded as a safe harbor. Ron Aucutt’s outline discusses trust capitalization in the context of the sale of assets for a note at Section VIII-K.

29. BORROW MONEY AND HAVE GRANTOR BUY LOW BASIS ASSETS FROM THE GRANTOR

TRUST. If a grantor trust is already in place, consider having the grantor with a short life expectancy purchase those assets from the trust for cash; perhaps with borrowed funds. Since the transaction is disregarded for income tax purposes the grantor would then hold the low basis assets at death accomplishing a basis step up.

30. SEPARATE GRANTOR TRUSTS FOR SEPARATE ASSETS (BUSINESSES). The grantor trust provisions are very beneficial from a transfer tax standpoint but, from the economic standpoint of the grantor, can present a cash flow hardship. A prime example would be a liquidity event (sale or merger) of a business held by the grantor trust which might trigger a substantial amount of gain with that tax being covered by the grantor. Grantors do not always like to pay income tax for the benefit of someone else. When structuring the grantor trust with all of the features discussed previously, consider establishing a separate grantor trust for each equity interest held in trust. For instance, the donor might want to transfer an equity interest in a real estate venture, stock in an actively traded business, or units of LLC member interest in a family investment company. Consider a separate grantor trust for each of those ownership interests. That would permit the settlor to “turn off” grantor trust status as to one entity but not as to other entities if a major income tax realization event is about to take place.



31. INHERITOR’S TRUST FOR CHILD WITH CREDITOR-MARITAL PROBLEMS. A spendthrift trust formulated to hold a child’s inheritance, possibly with the child acting as trustee and having withdrawal rights under H.E.S.M., can provide meaningful asset protection while still providing ongoing economic benefit and partial control to the child. The trust can provide meaningful asset protection as well as transfer tax minimization. Consider the Inheritor’s Trust as a substitute for the premarital agreement that never got drafted or never got signed.

IDEAS FROM ALL OVER

32. GRAEGIN LOAN LEVERAGE; OREGON TAX SAVINGS BONUS. Effective in 1998 Congress amended the provisions of IRC §6166 to provide that interest payable on deferred estate taxes under IRS §6166 was not deductible for purposes of computing the taxable estate. (IRC §2053(c)(1)(D)). Prior to that amendment interest on deferred estate taxes became deductible as paid necessitating the equivalent of an amended federal estate tax return each year during the 6166 period. Oregon has no provision comparable to the special rules under IRC §6166. While Oregon permits deferrals on a discretionary basis, statutory interest is payable with each installment, and would constitute a deductible item under IRC §2053. So if you defer both federal and Oregon estate taxes you will still be in a position requiring amendment of both returns in each year if you take the Oregon interest as a 2053 deduction. Clients are often concerned about having liquidity to pay the estate tax. Many ILITs have been proposed and formulated to provide liquidity at the death of the surviving spouse. However, compared to §6166 and ILIT planning, the Graegin loan concept is mathematically superior in terms of net present value passing to beneficiaries by allowing an estate tax deduction (both federal and Oregon) for 100% of the interest that will accrue over the term of the Graegin loan, so long as the loan requires full payment of all the interest whether or not there is a prepayment. The Graegin loan is only available to the extent that the estate lacks liquidity to pay estate taxes. Therefore planning to be illiquid may provide a substantial estate tax savings at the combine state and federal 50% estate rate. The Graegin loan allows an estate tax deduction for all the interest that will accrue over the term of the loan so long as the loan requires payment of all interest that would accrue over the loan whether or not there is a prepayment. A typical Graegin loan arrangement would have the estate obtain the loan from a financial institution with collateral provided by an LLC or other investment company affiliated with the family. The estate would pay a loan fee to the family investment company, deducted on the 706, for its provision of the collateral.



Some arrangements have been made where the loan is directly from the family LLC when that LLC is owned in similar proportions to the beneficial interests in the estate. The IRS is attacking those arrangements as shams.

33. PROTECTIVE 6166 ELECTION EVEN IF LOOKS LIKE THE BUSINESS DOESN’T QUALIFY. Even if the estate looks like it would not qualify for the threshold of §6166 (35% of the value of the adjusted gross estate being in closely held businesses), consider making the §6166 election anyway. It is possible that the estate’s perception of value will be different from that of the IRS, and having the §6166 election in place can ease the burden of paying tax while the valuation dispute is resolved.

34. DO PLANNING IN LITTLE CHUNKS DURING LIFETIME WITH LOTS OF GIFT TAX RETURNS; THE IRS PROBLEM OF FIGURING WHICH QUAIL TO SHOOT IN A BIG COVEY. The IRS audits to produce maximum revenue despite pronouncements to the contrary. With its limited resources the audit lottery is based on the revenue potential to the government. Lifetime planning allows multiple incremental transfers each of which carries a smaller tax potential than leaving all of the assets to be included on the 706. Consider breaking up gifts to grantor trusts or Wandry-style sales in to two years, straddling the closing of business on December 31 and the beginning of business on January 1. This splits the transaction between gift tax returns in two years. This also allows you to use a single valuation report for gifts and sales disclosed in separate years. Also consider limiting values using defined value clauses to preserve meaningful amounts of exemption. The IRS will certainly take into account its revenue potential in challenging a valuation when the donor has significant remaining exemption to cushion any revaluation by the IRS. In the case of gift tax returns filing often is a good idea.

35. OREGON NRC; PLANTING CROPS AND TREES AS “REPLACEMENTS” FOR HARVESTED ASSETS. Oregon’s Natural Resources Credit (ORS 118.140) provides for recapture of Oregon estate tax if the NRC was claimed and NRC property is not held for five out of the eight calendar years following the decedent’s death. A disposition will trigger recapture unless there is replacement with real or personal property after the credit is claimed and that replacement must take place “within one year.” Those who grow trees for a living, farm for a living or raise livestock for a living typically need to dispose of timber, crops or livestock on a periodic basis to generate cash flow (that is what they are in business for). The provision allowing replacement without recapture (ORS 118.140(9)(d)) does not make clear that the proceeds realized from the sale of timber, crops or livestock has to be the source for acquiring the replacement property.



However, Oregon Department of Revenue Form OR 706-A (Oregon Additional Estate Transfer Tax Return, See Exhibit 35) makes it clear that the Oregon Department of Revenue thinks that there has to be tracing from the proceeds of the disposed property. So for a tree farmer, will it be sufficient to replant within one year? For the rancher who has sold cattle, does a newborn calf replace a heifer sold to a feed lot? Prudence would suggest that dollar amounts be identified and traced through to the replacement property even if the size of the herd has to be expanded or the size of the tree farm has to be enlarged. With the disposition of inventory (timber, crops or livestock) if proceeds must be traced on a monetary basis to the replacement property, how does the entity make distributions to its shareholders or members as it normally would? The answer may be that utilization of the NRC may trigger the need for line of credit borrowing to balance out the cash flow and permit the owners to receive distributions.

SPECIAL LESSONS FROM THE PAST

36. WHY A CYNIC THINKS THE FEDERAL ESTATE TAX WILL NOT BE REPEALED. We all know that the Republican-controlled Congress will pass legislation repealing the estate tax, but presumably preserving the stepped up basis. We also know that the sitting President will veto that legislation. This scenario fits perfectly with the Republican objective to keep donors with large estates pumping money into the coffers to press forward estate tax repeal. But will repeal really happen when that would eliminate a lucrative cause for which to fight?

37. TRAIN YOUR ASSOCIATES AND PARALEGALS. See checklists at Forms 37A and 37B.

38. REMEMBER EARL LONG’S ADMONITION. Be careful! These words of wisdom are available after this presentation in the lobby. (See Form 38).



[client last name] Residential Trust Agreement Page 1 of 2

FORM 2

[CLIENT LAST NAME] RESIDENTIAL TRUST AGREEMENT

BETWEEN: [CLIENT FULL NAME] (the “Settlor”); AND: [CLIENT FULL NAME] (the “Trustee”). DATED: __________________, 2011

1. By Warranty Deed executed concurrently with this [client last name] Residential Trust Agreement (the “Trust Agreement”), the Settlor has conveyed to the Trustee the legal title to certain real property and improvements located at [street address], also known as Map & Tax Lot Number [map & tax lot #] (tax account number [tax account #]), and more particularly described as:

[legal description]

in Lane County, Oregon (the “Property”).

2. The Settlor shall have the exclusive right to occupy, use, inhabit and enjoy the Property as [his/her] personal residence, or otherwise, during [his/her] lifetime.

3. All economic rights in the Property shall be enjoyed by the Settlor during [his/her] lifetime, and no rent shall be paid or payable with respect to the use or occupancy of the Property by the Settlor under this Trust Agreement. In addition, any rent or other income derived from use of the Property, whether or not the Settlor is occupying or using the Property, shall be the sole and exclusive property of the Settlor.

4. During the term of this Trust Agreement the Settlor shall pay all expenses associated with the use and maintenance of the Property including, but not limited to, property taxes, utilities, maintenance fees, insurance and other costs associated with the Property’s use and occupancy. The Settlor shall add the Trustee as a named insured with respect to any liability and casualty insurance policies maintained with respect to the Property.

5. Upon any sale, condemnation or other conversion of the Property by sale, exchange or otherwise, the resulting property or proceeds shall be the sole and exclusive property of the Settlor during [his/her] lifetime.

6. This Trust Agreement shall terminate at the time of the death of the Settlor and the Property shall then be conveyed to [beneficiary/successor trustee name] if living or to the issue of [beneficiary/successor trustee name] by right of representation if [beneficiary/successor trustee name] is not then living.

7. [client full name] shall act as the Trustee under this Agreement. If [client full name] dies, resigns, becomes incapacitated or otherwise ceases to act as the Trustee, then [beneficiary/successor trustee name] shall act as successor Trustee.



[client last name] Residential Trust Agreement Page 2 of 2

8. The Trustee shall have all powers conferred on a trustee by the laws of Oregon for the orderly administration of the trust estate, including those specified in the Oregon Uniform Trust Code as it may be amended from time to time.

9. This Trust Agreement may be modified, amended or revoked by the Settlor at any time.

Dated and effective as of the date first appearing above.

SETTLOR: TRUSTEE: ______________________________ ___________________________________ [client full name] [client full name] STATE OF ____________ ) ) ss. County of ______________ ) On this ____ day of ______________, 20__, personally appeared the above named [client full name], as Settlor and Trustee, and acknowledged the foregoing instrument to be [his/her] voluntary act and deed. _____________________________ Notary Public for _______________ My Commission Expires:



FORM 4

Amendment No. 1

AMENDMENT NO. ____

________________ REVOCABLE TRUST

On_______________, __________________as Settlor and __________________as Trustee entered into the ______________________________Revocable Trust Agreement (the “Agreement”). Pursuant to Section _____________of the Agreement __________________has reserved the power to modify or alter the Agreement with the consent of the Trustee. ____________________, as both Settlor and Trustee, hereby amends the Agreement as follows: Section _________________ of the Agreement is amended and restated to provide as follows:

“____. Primary and Successor Trustees. _______________and ___________________________shall both serve as the Trustee under this Agreement and each may act alone with all the powers and authority of the Trustee without the consent of the other. If ____________________________fails or ceases to serve as Trustee, ____________________________shall serve as Trustee. If all of the above named persons fail or cease to serve as Trustee, ______________________________shall serve as Trustee.”

This Amendment No. 1 is effective as of this date. Executed this ____ day of _________________, 201__. ______________________________ _________________, Settlor ______________________________ __________________, Trustee ______________________________ __________________, Trustee





FORM 5

(20) Client Status. To act on my behalf as client with my attorney, accountant, broker, insurance agent and other professional advisers (without waiver of any confidentiality privilege), to receive any confidential information about me, to exercise or waive any confidentiality privilege on my behalf, and to hire or discharge any of the foregoing on my behalf as client.





EXHIBIT 14 Roth Conversion Checklist 1. Client has sizable IRA 2. Client has liquid assets outside IRA 3. Client unlikely to be in lower income tax brackets later in

life 4. Client can afford the tax in 2010 without spreadout of tax

4.1. Elect out of 2011 and 2012 taxation 5. Client can hold the Roth without consumption to pass to

children 6. Children will be patient and spread out tax free

distributions 7. Client believes the Oregon "surtax" (Measures 66 and 67)

are permanent 8. Client willing to use the Roth at the aggressive side of

the investment spectrum with long deferral expected 9. Remember "recharacterization" for those who have

buyers' remorse up to October 15 of 2011 9.1. Maybe do multiple conversion and can "unconvert" some but not all of the

separate roth accounts 10. Consider that Congress could decide to tax Roth

accounts later





FORM 17

____. Qualified Retirement Plan and IRA Benefits. All other provision of this Agreement notwithstanding, during each calendar year beginning with the year of the Settlor’s death, the Trustee shall withdraw from each plan, trust, account or other arrangement subject to Section 401(a)(9) of the Code (the “Qualified Account”), and of which the Trustee or this Trust is the beneficiary, the Minimum Required Distribution (the “MRD”) for that year. The Trustee shall immediately distribute the MRD to the Beneficiary during the Beneficiary’s lifetime. All distributions received by the Trustee from a Qualified Account exceeding those described in the preceding sentence shall also be immediately distributed to the Beneficiary during the Beneficiary’s lifetime. After the death of the Beneficiary, any distribution received by the Trustee from a Qualified Account shall be held and applied as part of the Trust Estate. Distributions described in this Section ___ shall not be charged with or reduced by any cost or expense including, but not limited to taxes, commissions, trustee compensation, or expenses of administering this Trust.





FORM 25

AMENDMENT TO OPERATING AGREEMENT OF

________________________, LLC

Recitals 1. Effective _____________________, ________________. and ____________________as Trustees of the __________________________________Trust (the “Member”) entered into a form of Operating Agreement respecting___________________________, LLC, an Oregon limited liability company, (the “LLC”). Pursuant to Section __________ of the Operating Agreement, Members holding a majority of units hereby amend the Operating Agreement as follows. Amendments. 1. Section __________ is amended to provide as follows:

____. Withdrawal. A member may voluntarily withdraw from the LLC and upon withdrawal the LLC shall be dissolved and the assets of the LLC shall be liquidated and distributed in accordance with Section_______.

2. Section ___________ is amended and restated to provide as follows: _____. Events of Dissolution. In addition to the provisions of Section ____, the LLC shall be dissolved

and its assets distributed upon affirmative vote of members holding _______percent (___%) of the units.

3. Section _____ is deleted. 4. Section _____ is deleted. 5. Section 8.3 is amended and restated to provide as follows: 8.3. Transferee Status. Notwithstanding any other provision of this

Agreement, any person who succeeds to the interest of a member, and complies with the provisions of Section ____, shall be admitted as a member and shall not be an assignee.

Dated and effective______________. ____________________________Trust By: _______________________________ By: ________________________________ _________________, Trustee ______________, Trustee





SPOUSAL EXEMPTION CAKE TRUST OR EXHIBIT 27SPOUSAL ANNUAL EXCLUSION-CREATED BY HUSBAND AND WIFEAVOIDING THE RECIPROCAL TRUST DOCTRINE

TRUST FEATURE TRUST 1 TRUST 2Settlor

Husband xWife x

Initial BeneficiaryHusband

WifeIssue

Initial TrusteeHusband

WifeSuccessor Trustee

childrenTrustee Names

Settlor Names (non subordinate or non-adverse)Additional Beneficiaries

Discretion to add charitiesIssue

Collateral RelativesGrantor trust because:

Power of substitutionsNonadverse party can add charities

Authority to pay insurance premiums on Life Insurance insuring Grantor

5 and 5 Withdrawl RightsStandards of Distribution

IncomeIncome only

Principal and Income for Health, Education, Support or Maintenance

Health OnlyOnly if net worth less than $x

Deferred for X yearsOnly with the consent of a non-adverse fiduciary

Standards for Distributions to Additional Beneficiaries

Principal and Income for Health, Education, Support or Maintenance

Income or Principal for Health and Education of Children Only

Limited Power of Appointment?By Will only

Intervivos and by WillTrust Termination

90 yearsR.A.P. 21 year rule

Distribution on TerminationIssue by Right of Representation

Children Per CapitaWhen Established? Now Later





FORM 28

STOCK GIFT AND SALE AGREEMENT Page 1 of 3

STOCK GIFT AND SALE AGREEMENT

PARTIES: ________________, Trustee of the _________________________ Long Term

Family Trust dated____________________, (“Purchaser”); and

__________________and______________________________, Trustee of the ______________________Revocable Trust UTD ______________(“Seller”)

DATED EFFECTIVE: __________________________ (the “Effective Date”)

AGREEMENT

In consideration of the mutual promises made herein, the parties agree as follows:

1. GIFT AND SALE OF STOCK

Seller hereby sells and transfers to the Purchaser as of the Effective Date _____________________( ) shares of the Class B nonvoting stock of__________________________. (the “Stock”). Of the Stock so transferred Seller makes a gift to the Purchaser of the lesser of: (1) all the Stock; or (2) that number of shares of the Stock which have a value, as of the Effective Date, equal to _____________________($__________________) as finally determined for United States Gift Tax purposes. That number of shares of the Stock not transferred by gift as provided in the preceding sentence is and shall be sold by the Seller to the Purchaser as of the Effective Date as provided below (the “Sold Stock”).

2. PURCHASE PRICE

The purchase price for the Sold Stock shall be the fair market value of the Sold Stock as of the Effective Date, based on the value of the Shares transferred by gift as finally determined for United States Gift Tax purposes (the “Purchase Price”).

3. PAYMENT

The entire balance of the Purchase Price plus all accrued interest will be represented and payable in the manner provided by the promissory note of Purchaser in the form attached as Exhibit A.

4. SELLER’S CLOSING DOCUMENTS

Upon closing, Seller shall execute and deliver to Purchaser a stock certificate or certificates for the Stock, along with all other documents and agreements necessary to effect transfer of ownership of the Stock to Purchaser.

5. PURCHASER’S CLOSING DOCUMENTS

Upon closing, Purchaser will execute and deliver to Seller the following documents:



FORM 28


5.1. Promissory Note. A promissory note in the form attached as Exhibit A.

5.2. Stock Pledge Agreement. A stock pledge agreement in the form attached as Exhibit B.

5.3. Security Agreement. A security agreement in the form attached as Exhibit C.

5.4. Financing Statements. Uniform Commercial Code financing statements, in a form reasonably satisfactory to counsel to Seller, as required to perfect Seller’s security interest(s).

6. SELLER’S REPRESENTATIONS AND WARRANTIES

Seller represents and warrants to Purchaser that Seller is the sole owner of the Sold Stock, free and clear of all encumbrances, and has good right to sell and transfer all such stock to Purchaser. This representation and warranty will survive the closing of the sale.

7. MISCELLANEOUS PROVISIONS

7.1. Transferability. Purchaser shall not assign or transfer any interest of Purchaser under this Agreement.

7.2. Binding Effect. The provisions of this agreement will be binding upon and inure to the benefit of the heirs, personal representatives, successors, and assigns of the parties.

7.3. Notice. Any notice or other communication required or permitted to be given under this Agreement must be in writing and mailed by certified mail, return receipt requested, postage prepaid, addressed to the parties at the following addresses:

Name Address

All notices and other communications will be deemed to be given at the expiration of three days after the date of mailing. The address of a party to which notices or other communications must be mailed may be changed from time to time by giving written notice to the other party.

7.4. Litigation Expense. In the event of a default under this Agreement, the defaulting party shall reimburse the non-defaulting party or parties for all costs and expenses reasonably incurred by the non-defaulting party or parties in connection with the default, including without limitation attorney’s fees. Additionally, in the event a suit or action is filed to enforce this Agreement or with respect to this Agreement, the non-prevailing party or parties shall reimburse the prevailing party or parties for all costs and expenses incurred in connection with the suit or action, including without limitation reasonable attorney’s fees at the trial level and on appeal.

7.5. Waiver. No waiver of any provision of this Agreement will be deemed, or will constitute, a waiver of any other provision, whether or not similar. No waiver will



FORM 28


constitute a continuing waiver. No waiver will be binding unless executed in writing by the party making the waiver.

7.6. Applicable Law. This Agreement will be governed by and construed in accordance with the laws of the state of Oregon.

7.7. Entire Agreement. This Agreement constitutes the entire agreement between the parties pertaining to its subject matter, and it supersedes all prior contemporaneous agreements, representations, and understandings of the parties. No supplement, modification, or amendment of this Agreement shall be binding unless executed in writing by all parties.

SELLER: _____________________________________ ________________________

PURCHASER: ______________________________________ ______________________________





150-104-007 (Rev. 07-14) 1 Form OR706-A Instructions

Instructions for Form OR706-A, Oregon Additional Estate Transfer Tax Return

Use this form only if you inherited natural resource property on or after January 1, 2012. If you inherited natural resource property before January 1, 2012, use Form IT-1A, Oregon Additional Inheritance Tax Return.

DefinitionsThe terms we use in these instructions are defined in Oregon Revised Statute (ORS) 118.140 and Oregon Administrative Rule (OAR) 150-118.140.

“Property” means natural resource property or commer-cial fishing property used for the natural resource credit on Form OR706.

“Property owner” means you, the person who received property from the decedent.

“Qualified use” means to use the property as a natural resource or commercial fishing business property.

“Disqualified property” means property that:

• You disposed of, or stopped qualified use of, beforefive out of eight calendar years had passed after thedecedent’s death.

• Was subject to an involuntary conversion and you didnot reinvest all of the proceeds from the involuntaryconversion.

“Involuntary conversion” as defined in the Internal Rev-enue Code (IRC), section 1033.

Taxable eventsThe property owner causes a taxable event if the property is not used as set out in ORS 118.140.

• The property is disposed of or the qualified use of theproperty stops before it is used for five out of eightcalendar years after the decedent’s death.

• Involuntary conversions—you may owe additional taxif you don’t reinvest the proceeds or reinvest only partof the proceeds from the involuntary conversion.

As the property owner, you are responsible for reporting and paying any additional estate transfer tax imposed by ORS 118.140. You must file Oregon Form OR706-A to report the taxable event. The additional tax is limited to the tax credit claimed on Form OR706. See example 1.

If you and other qualified family members shared owner-ship of the property and you stop the qualified use, your additional tax will be based only on your share of the property. See example 2.

Nontaxable events for disposition to a family memberProperty is not disqualified if you transfer the property to:

1. Another member of the decedent’s family; or

2. The decedent’s registered domestic partner; or

3. Another entity eligible for the credit. Note: Nontaxableevents described above relate only to the addition estatetransfer tax per chapter 118. If a sale takes place, evento a family member, the seller may have a capital gainwhich would be reported on their personal incometaxes.

See example 3.

Even if you don’t owe tax, you must complete and file Form OR706-A to notify us of a change in property own-ership. Complete only parts 1, 2, 5, and 6 of this form.

Replacement of natural resource property and involuntary conversionsRead below for information on when to file a return in the case of replacement property or involuntary conversion.

Replacement of property. After the credit is claimed, you may replace natural resource property with real or personal property, as long as the replacement property is used as natural resource property and all proceeds are reinvested in natural resource property. Real property for which the credit was claimed may only be replaced with real property. The replacement property must be acquired within one year to avoid a disposition and additional tax. See example 4.

Involuntary conversions. If, within two years of an invol-untary conversion, you reinvest all proceeds in qualified replacement property, you won’t owe additional estate transfer tax. Complete parts 1–3 and 6 to notify us that an involuntary conversion took place, even though you owe no tax. If you don’t replace the property within two years of the involuntary conversion, you’ll owe additional tax.

Partially taxable involuntary conversions. If you paid less for the qualified replacement property than you received in the involuntary conversion or you don’t rein-vest the entire amount received from the conversion, then the conversion is partially taxable. See example 5.

Return due dateGenerally. File Form OR706-A and pay any additional taxes due within six months after you disposed of the property or ended the qualifying use.

Exchange or involuntary conversionThe tax return and additional tax are due six months from the taxable event. A taxable event takes place only when your property isn’t replaced within the allowed time. For

EXHIBIT 35




example, if your property is subject to an involuntary con-version on February 15, you have until February 15 of the following year to replace the natural resource property. If you don’t do so within the year, a taxable event has taken place. The additional estate transfer tax return is due six months from the taxable event (in this example, August 15, six months from February 15).

Extensions To request an extension of time to file or pay, you must complete and mail federal Form 4768 to us by the original due date of Form OR706-A.

Extension of time to file. When we receive your exten-sion request, you’ll have an automatic six month extension of time to file. Include a copy of this extension with your Form OR706-A. An extension of time to file doesn’t extend the time to pay the tax.

Extension of time to pay tax. Along with your federal Form 4768, you must also attach a written statement detailing why you can’t pay the tax by the original due date. If you don’t provide a written statement, the request will be denied. We’ll send you a copy of your extension request either approving or denying your extension. Once your tax return is filed and an extension to pay is approved, you must provide collateral in an amount twice the amount of unpaid tax to secure the debt. An extension of time to pay the tax does not extend the time to file the tax return.

Interest accrues on any unpaid tax during the extension period.

Interest and penaltyInterest owed on additional estate transfer tax starts the day after the due date of Form OR706-A, excluding extensions. If you don’t pay the tax within 60 days of our billing notice, the interest rate increases by 4 percent per year. If you have an approved extension of time to pay, the additional 4 percent wouldn’t apply.

Interest accrues on any unpaid tax during an extension of time to file. Here’s how to calculate the interest due:

Tax x Annual interest rate x Number of full yearsTax x Monthly interest rate x Number of monthsTax x Daily interest rate x Number of days

For periods beginning Annual Monthly Daily

January 1, 2015 4% 0.3333% 0.0110%January 1, 2014 4% 0.3333% 0.0110%January 1, 2013 4% 0.3333% 0.0110%

If you file your return after the due date, including the extended filing due date, add a late filing penalty of 5 percent to the tax amount. If you file your return more than three months after the due date or the extended

filing due date, add an additional 20 percent penalty for a total penalty of 25 percent.

If your tax is unpaid as of the due date, including any approved extension of time to pay, add a late payment penalty of 5 percent of the tax.

What to file• Form OR706-A for each property owner.• Copy of extension, federal Form 4768, if applicable.• Copy of Schedule NRC.• Copy of sales document as applicable.• Supporting documentation for involuntary conversion

of property.• On Form OR706-V, Oregon Estate Transfer Tax Payment

Voucher, 150-104-172, make sure you check the additional tax OR706-A return (148) box, include your name and Social Security number on the payment voucher in the name of executor box.

• Payment—make your check or money order payable to the Oregon Department of Revenue. Include your name, Form OR706-A, and the year the qualified use of the property stopped.

Line instructionsSpecific line instructions are provided for lines not fully described on Form OR706-A.

Part 1—Property owner information

Enter the name of the property owner, SSN, address, and phone number.

If you have applied for an extension to file or extension to pay, check the corresponding boxes.

Enter the name of the decedent from whom you inherited the property. Enter the decedent’s date of death and SSN.

Part 2—Description of property

Note: References to Schedule NRC are for “Schedule NRC for deaths on or after January 1, 2012.”

Column A—Enter the description of the disqualified property.

Column B —Enter the date the property was sold, exchanged, or converted.

Column C—Enter the value of the property listed in column A that was used in the formula to calculate the natural resource credit (NRC). This amount is from Schedule NRC, part 2, column D.

If jointly own property or only part of the property is disqualified, enter only the value of the disqualified portion or your share of the property. For example, the estate claimed natural resource property on Schedule NRC for a farm with a value of $1,000,000. The farm was inherited equally by two brothers. After a year of farming one brother decides to stop farming his share. Column C will have $500,000.




Column D—Enter the proceeds from the sale, exchange, or conversion of the property listed in column A.

Column E—Enter the amount from the proceeds that wasn’t reinvested in a qualified natural resource property.

Column F—Divide the amount of column E by column D (round to two decimal places). This is the disqualified percentage.

Column G—Multiply the percentage in column F with the amount in column C. This is the disqualified value.

Total the amounts in column G.

Part 3—Property replacement

If you’ve replaced your natural resource property with another qualified natural resource property or have reinvested the proceeds from an involuntary conversion on another qualified natural resource property complete this section.

Column A—Enter the acquisition date of the new property.

Column B—Enter the description of the newly acquired natural resource property as result of an exchange or involuntary conversion. Also describe which property was replaced. Note: this property should be listed on part 2.

Examples

Example 1

Jack inherited a farm from his father with a date of death value of $1,000,000 and farm equipment value of $200,000. After running the farm for 18 months, Jack decided to sell the farm and all the equipment. His Schedule NRC shows the following information: adjusted gross estate $1,950,000; tax payable $96,125; and natural resource credit claimed $59,598. Jack will pay additional estate transfer tax of $41,719, calculated as follows:

Line 1 ........$ 1,200,000 Line 7 .................$ 0.00Line 2 ........$ 1,200,000 Line 8 ............. $ 59,598Line 3 ......................$ 0 Line 9 ............. $ 59,598Line 4 ........ $ 1,950,000 Line 10 .....................42Line 5 ....................0.00 Line 11 ................. 0.70Line 6 ............. $ 96,125 Line 12 ........... $ 41,719

Example 2

Assume same facts as example 1, except Jack inherited the farm equipment and his brother, David, inherited the farm. After operating the farm together for 18 months, David decides to lease the farmland. Jack sells his farm equipment for $202,000 and buys a cottage with the sale proceeds. David doesn’t have additional estate transfer tax because the land remains in qualified use. Jack will file OR706-A, completing parts 1, 2, 4 and 6. On part 2, column C, Jack will enter $200,000, the value of the

equipment he inherited and sold. On column D he will enter $202,000 the proceeds of the sale and $0 on column E. Jack will pay additional estate transfer tax of $7,403, calculated as follows:

Line 1 ........$ 1,200,000 Line 7 ............. $ 49,024

Line 2 ...........$ 200,000 Line 8 ............. $ 59,598

Line 3 ........$ 1,000,000 Line 9 ............. $ 10,574

Line 4 ........ $ 1,950,000 Line 10 .....................42

Line 5 ....................0.51 Line 11 ................. 0.70

Line 6 ............. $ 96,125 Line 12 ............. $ 7,403

Example 3

Assume the same facts as in example 2, except that David and Jack sold the farm and the farm equipment to their brother Joseph. Because the property was sold to a family member, David and Jack don’t pay additional estate trans-fer tax per ORS 118.140. David and Jack may have a capital gain as a result of the sale of the property that would be reported on their personal income taxes.

David and Jack will each complete and file Form OR706-A, parts 1, 2, 5, and 6, to report the sale of the NRC prop-erty to family member.

Example 4

Anthony inherited a farm with value of $1,200,000 from his great aunt Vanessa, who passed away June 12, 2012. The estate claimed an NRC of $45,200 on Form OR706. On April 12, 2014, the city annexed the farm and paid Anthony $1,200,000. On May 16, 2015, Anthony decided to reinvest all of the proceeds from the involuntary conversion and purchased another farm for $1,200,000. Anthony doesn’t have to pay additional estate transfer tax because he reinvested all the proceeds from the involun-tary conversion on another farm within 2 years from the involuntary conversion. Anthony will file Form OR706-A and complete parts 1, 2, 3, and 6, to notify the Department of Revenue that the involuntary conversion took place.

Example 5

Assume the same facts as example 4, except that Anthony purchased another farm for $1,050,000 and purchased an RV for personal use for $150,000. Anthony would need to pay additional tax on the $150,000 because he didn’t rein-vest that portion of the proceeds. The tax payable on Form OR706 was $60,250, the NRC claimed was $45,200, and the adjusted gross estate was $1,600,000. Anthony would calculate his additional estate transfer tax as follows:

Line 1 ........$ 1,200,000 Line 7 ............. $ 39,765

Line 2 ...........$ 150,000 Line 8 .............$ 45,200

Line 3 ........$ 1,050,000 Line 9 ...............$ 5,435

Line 4 ........$ 1,600,000 Line 10 .................... 38

Line 5 ....................0.66 Line 11 ................. 0.63

Line 6 .............$ 60,250 Line 12 .............$ 3,424




Have questions? Need help?Email ........................................ [email protected] email address is not secure and confidentiality cannot be ensured. General tax and policy questions only. We ask that professional tax preparers and attorneys research questions before contacting us.

Write to .............................Estate Audit, Business Division Oregon Department of Revenue, PO Box 14110, Salem OR 97309-0910. Include the property owner’s SSN, the decedent’s SSN, and a daytime phone number for faster service.

General tax information ................ www.oregon.gov/dor Salem ............................................................ 503-378-4988 Toll-free from an Oregon prefix ............1-800-356-4222

Asistencia en español: En Salem o fuera de Oregon ..................... 503-378-4988 Gratis de prefijo de Oregon ...................1-800-356-4222

TTY (hearing or speech impaired; machine only): Salem area or outside Oregon .................. 503-945-8617 Toll-free from an Oregon prefix ............ 1-800-886-7204

Americans with Disabilities Act (ADA): Call one of the help numbers above for information in alternative formats.



150-104-007 (Rev. 07-14) Form OR706-A, page 1 of 2

This form should be used to report and pay additional estate transfer tax imposed by Oregon Revised Statute (ORS) 118.140 for an early disposition or an early cessation of use of qualified natural resource property or commercial fishing property. You’ll need your copy of the original Schedule NRC to complete this form. Note: For recapture of the natural resource credit taken on Form IT-1, Oregon Inheritance Tax Return (for deaths prior to January 1, 2012), use Form IT-1A, Oregon Additional Inheritance Tax.

Property owner’s SSN or FEINName of property owner

Part 1

Extension of time to file is attached. Extension of time to pay is attached.

Decedent’s Social Security numberDecedent’s date of deathName of decedent

Property owner’s current mailing address Property owner’s phone

Part 2—Description of property (see instructions)

A. Property descriptionB. Date of disposition

C. Value of property listed on column A (see Schedule NRC, column D)

D. Proceeds from sale / exchange / conversion

E. Proceeds not reinvested

F. Disqualified percentage (E ÷ D)

G. Disqualified property (F x C)

Total

Part 3—Property replacement & involuntary conversion of property (see instructions)

A. Date of acquisition B. Property description of newly acquired property and the property that was replaced

Oregon Additional Estate Transfer Tax Return

For office use onlyDate received

Payment

BIN

•

•

•

Form

OR706-A(147)

•



150-104-007 (Rev. 07-14) Form OR706-A, page 2 of 2

Part 4—Additional estate transfer tax computation (references to Schedule NRC are for use with Form OR706)

1. Enter total from Schedule NRC, part 2, column D ..........................................................................................1

2. Enter total from Form OR706-A, part 2, column G .........................................................................................2

3. Subtract line 2 from line 1 ..............................................................................................................................3

4. Adjusted gross estate (Schedule NRC, part 5, line 3).....................................................................................4

5. Divide line 3 by line 4 (round to two decimal points) ......................................................................................5

6. Tax payable (Schedule NRC, part 5, line 8) ....................................................................................................6

7. Multiply line 5 by line 6 ..................................................................................................................................7

8. Original NRC credit claimed (Schedule NRC, part 5, line 9) .........................................................................8

9. Subtract line 7 from line 8 .............................................................................................................................9

10. Enter the result of: 60 minus the number of months the property was used as natural resource property ... 10

11. Divide line 10 by 60 (round to two decimal points) .....................................................................................11

12. Multiply line 9 by line 11. This is your additional estate transfer tax (don’t enter more than the amount on line 8) ..............................................................................................12

13. Penalty due (see instructions) .....................................................................................................................13

14. Interest due (see instructions) .....................................................................................................................14

15. Add lines 12 through 14. This is your total due ...........................................................................................15

Social Security numberName of qualifying family member

Address

Part 5—Disposition of property to a decedent’s family member

If you sold or gifted your NRC property to another member of the decedent’s family, complete this section (see instructions). If there is more than one person, attach an additional statement and include all of the information requested here.

Relationship to decedent Phone

Signature of owner

Signature of preparer

X

X

Under penalties of false swearing, I declare that I have examined this return, including accompanying schedules and statements. To the best of my knowledge and belief it is true, correct, and complete. If prepared by a person other than the executor, this declaration is based on all information of which the preparer has any knowledge.

Mail to:

Oregon Department of RevenuePO Box 14110Salem OR 97309-0910

Attach a complete copy of your Schedule NRC and supporting documents.

Date

Name of preparer Title

Phone

Mailing address City State ZIP code

Part 6—Signatures and authorization

Check the box to authorize the following individual(s) to receive and provide confidential tax information relating to this tax return.



EXHIBIT 37A Estate Planning Associate Training Curriculum and Projects

1. Basic Devices 1.1. Durable power of attorney 1.2. Health care directive 1.3. HIPAA authorization 1.4. TOD and POD devices (bank accounts and securities 1.5. Will form 8-simple will 1.6. Will form 9-trusts for children 1.7. Will form 11-credit shelter plus children trusts

1.7.1. Choice of funding formulas 1.8. Corresponding living trusts

1.8.1. Funding living trusts 1.9. Beneficiary designations

1.9.1. Life insurance 1.9.2. Retirement plans and IRAs

1.10. Spreadsheet model 1.11. Death tax apportionment 1.12. Client interview process 1.13. Planning with second marriages

2. Tax Concepts 2.1. EGTRRA credit shelter 2.2. Federal marital deduction 2.3. Oregon inheritance tax-marital deduction 2.4. Gift tax statute of limitations 2.5. 2036 retained interests 2.6. Non-citizen spouse



2.7. Generation skipping tax 2.8. Basis step up

3. Sophisticated Trust Planning 3.1. QTIP marital share with generation skipping (form 12) 3.2. Irrevocable life insurance trust (ILIT) 3.3. Generation skipping trusts and gifts 3.4. Spousal annual exclusion trust (SLET) 3.5. Qualified personal residence trust (QPRT) 3.6. Joint credit shelter trust (with basis step up) 3.7. Charitable remainder trusts (CRT) 3.8. Grantor retained annuity trust (GRAT) 3.9. Inter vivos QTIP for unpropertied spouse (IVQTIP) 3.10. Sale to a grantor trust 3.11. Special needs trusts

4. Other Planning Techniques 4.1. Use of disclaimers (formula) 4.2. LLC discount planning 4.3. Discounting undivided interests 4.4. Ordering and reviewing appraisal reports 4.5. 529 plan 4.6. Asset protection planning 4.7. Roth conversions 4.8. 6166 payment of estate tax 4.9. Graegin loan 4.10. Donor advised charitable fund 4.11. Conservation easements 4.12. Commercial annuities 4.13. Trust reformation 4.14. Endowment fund agreement reformation



4.15. Insolvent estate proceeding

5. General Higher Level Estate Planning Issues 5.1. UTC 5.2. Community property 5.3. Formula gifts and charitable disclaimers 5.4. 754 elections (optional basis adjustment) 5.5. Required minimum distributions from ira 5.6. Principal and income-unitrust rules 5.7. Inter vivos QTIP 5.8. Valuation discounts 5.9. Dynasty trusts 5.10. Changing domicile 5.11. Changing trust situs 5.12. Asset protection planning 5.13. Income taxation of trusts, estates and beneficiaries 5.14. Use of grantor trust 5.15. Net gifts (and net net gifts) 5.16. Will contest involvement

6. Related Project Skills 6.1. LLC organization

6.1.1. Single member LLC 6.1.2. Business LLC 6.1.3. Investment (super) LLC

6.2. Buy-sell agreements 6.3. Statutory deeds 6.4. Promissory note 6.5. Deed of trust 6.6. Premarital agreements 6.7. S-corporation issues



6.8. Corporate/LLC minutes 6.9. Probate administration 6.10. Prepare 706 estate tax return (also IT-1)

7. Ancillary Projects 7.1. Integrate U.T.C. into forms 7.2. Engagement letters

7.2.1. Probate 7.2.2. Trust administration 7.2.3. Estate planning

7.3. Client questionnaire



EXHIBIT 37B

Estate Planning and Administration Legal Assistant 1. Planning

1.1. Basic will 1.2. Codicils 1.3. Durable power of attorney 1.4. Health care directive 1.5. Basic revocable trust

1.5.1. Special residential trust 1.5.2. Trust certification

1.6. Beneficiary designations 2. Administration

2.1. Survivorship rights 2.1.1. Tenancy by the entireties 2.1.2. Joint tenancy with right of survivorship 2.1.3. Vehicle transfers 2.1.4. TOD 2.1.5. POD 2.1.6. Life insurance 2.1.7. Commercial annuities 2.1.8. IRA 2.1.9. Retirement accounts 2.1.10. PERS 2.1.11. Social Security

2.2. Intestate succession-statutory will 2.3. Marital property rights

2.3.1. Tenancy by the entireties 2.3.2. Community property



2.3.3. Elective share 2.4. Duties of executor-personal representative 2.5. Small estate proceeding 2.6. Full probate

2.6.1. Petition 2.6.2. Set up estate bank account 2.6.3. Apply for EIN 2.6.4. Notice to heirs and devisees 2.6.5. Notice to OHA and OSHS 2.6.6. Creditor notices 2.6.7. Creditor review checklist 2.6.8. Inventory 2.6.9. Annual/final accountings 2.6.10. Affidavit of compliance 2.6.11. Distribution

2.6.11.1. PR deed 2.6.11.2. Motor vehicles 2.6.11.3. Bank and investment accounts

2.6.12. Attorney fee affidavit 2.6.13. Computing PR fee 2.6.14. Prepare and obtain receipts 2.6.15. Closing

2.7. Trust administration 2.7.1. Trust certification 2.7.2. Apply for EIN 2.7.3. Creditor notices 2.7.4. Notices to beneficiaries

2.8. EIN application



3. Estate Tax Returns 3.1. Oregon 706

3.1.1. Oregon marital election 3.1.2. Oregon natural resources election

3.2. Federal 706 4. Guardianships and Conservatorships

4.1. Appointment of guardian/conservator 4.2. Notice to protected person 4.3. Annual reporting to court





EXHIBIT 38

To expand on the admonition of Earl Long, son of Huey Long and governor of the great state of Louisiana: Don’t email anything you can write in a letter. Don't write in a letter anything you can phone. Don't phone anything you can talk in person. Don't talk in person anything you can whisper. Don't whisper anything you can smile. Don't smile anything you can nod. Don't nod anything you can wink.



Chapter 6

Asset Protection Planning: A Few Simple Techniques and an In-Depth Look at

Domestic Asset Protection Trusts1

JoShua huSbandS

Holland & Knight LLPPortland, Oregon

1 © 2015 by Holland & Knight LLP.

Contents

I. Give It Away . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–1A. Transfers Fraudulent as to Present Creditors . . . . . . . . . . . . . . . . . . . . . . . . 6–1B. Transfers Fraudulent as to Present and Future Creditors . . . . . . . . . . . . . . . . . 6–3C. Creditors’ Remedies and Transferee Defenses . . . . . . . . . . . . . . . . . . . . . . . 6–4D. Statute of Limitations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–4

II. Invest In/Own Exempt Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–5Washington . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–5Oregon . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–7

III. Entity Planning. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–7

Domestic Asset Protection Trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–8I. Asset Protection Trusts Generally . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–8II. Tax Consequences Relating to APTs . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–13III. Case Studies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–14IV. Attorney Protocol for Establishing APTs . . . . . . . . . . . . . . . . . . . . . . . . . 6–22

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–23

Chapter 6—Asset Protection Planning




I. GIVE IT AWAY

A creditor cannot take from a debtor what the debtor does not own. An irrevocable transfer of property to another individual or to an irrevocable trust is the most effective asset protection technique in existence. It is also simple and typically inexpensive. However, a gratuitous transfer to another person, legal entity or irrevocable trust must be done well in advance of a creditor's claim or there is the possibility that the creditor will be able to reach the transferred asset by proving the transfer was fraudulent.

Washington Uniform Fraudulent Transfer Act Washington's Uniform Fraudulent Transfer Act describes fraudulent transfers in two

main ways. First, some transfers are fraudulent only as to present creditors. Second, other transfers are fraudulent as to both present and future creditors.

A. Transfers Fraudulent as to Present Creditors

There are two main ways that transfers can be fraudulent as to existing creditors: (1) the debtor is insolvent and did not receive equivalent value for the exchange; and (2) the transfer was to an "insider."

1. Debtor Insolvency

As to existing creditors only, a transfer or obligation is fraudulent if the debtor did not receive "reasonably equivalent value" in the exchange and the debtor was insolvent or "became insolvent as a result of the transfer or obligation." Wash. Rev. Code § 19.40.051(a).

The statute does not define "reasonably equivalent value," but it provides an example

which satisfies the inquiry. For purposes of this provision, the requirement is satisfied if a person acquires the debtor's interest through a "regularly conducted, noncollusive foreclosure sale" or through a "power of sale . . . upon default under a mortgage, deed of trust, or security agreement." § 19.40.031.

Insolvency is defined as where a debtor's debts are greater than his collective assets, "at a

fair valuation." § 19.40.021(a). Insolvency is presumed where a debtor is "generally not paying his or her debts as they become due[.]" Id. at (b). Partnership insolvency is determined by subtracting from its debts all partnership assets as well as each general partner's nonpartnership assets less its nonpartnership debts. Id. at (c).

Assets which are transferred with actual intent to hinder, delay, or defraud, or which are

transferred in such a way that the transfer is voidable under the Act, are not included as assets for this provision. Id. at (d); see Section I-C, infra at 4–5. Additionally, for insolvency purposes, debts "do not include an obligation to the extent it is secured by a valid lien on property of the debtor not included as an asset." Id. at (e). "Valid lien," in turn, is defined as a "lien that is effective against the holder of a judicial lien subsequently obtained by legal or equitable process or proceedings." § 19.40.011(13).



2. Transfers to Insiders

Additionally, a transfer is fraudulent as to existing creditors if: (1) "the transfer was made to an insider for an antecedent debt"; (2) the debtor was insolvent at the time of transfer; and (3) "the insider had reasonable cause to believe that the debtor was insolvent." Wash. Rev. Code § 19.40.051(b). For determination of whether a debtor is "insolvent," see Section I-A-1, supra at 1–2.

The Act includes an extensive definition of the term "insider" which depends on the

status of the debtor. For individual debtors, insiders include: (A) the debtor's relatives and relatives of "a general partner of the debtor"; (B) any "partnership in which the debtor is a general partner"; (C) another general partner of a partnership in which the debtor is a general partner; and (D) a "corporation of which the debtor is a director, officer, or person in control[.]" § 19.40.011(7)(i).

For corporate debtors, insiders include: (A) corporate directors; (B) corporate officers;

(C) persons "in control" of the corporation; (D) a "partnership in which the debtor is a general partner"; (E) any other general partner in a partnership in which the debtor is a general partner; and (F) a "relative of a general partner, director, officer, or person in control of the debtor[.]" § 19.40.011(7)(ii).

For debtors that are partnerships, insiders include: (A) general partners of the partnership;

(B) relatives of "a general partner in, or a general partner of, or a person in control of the debtor"; (C) "[a]nother partnership in which the debtor is a general partner"; (D) another general partner in a partnership in which the debtor is a general partner; and (E) a "person in control of the debtor[.]" § 19.40.011(7)(iii).

Insiders also include the debtor's affiliates and insiders of affiliates. § 19.40.011(7)(iv).

"Affiliates" include: (i) anyone who owns twenty percent or more of the voting securities of the debtor; (ii) a corporation owned twenty percent or more by the debtor (determined by voting shares); (iii) any "person whose business is operated by the debtor under a lease or other agreement, or a person substantially all of whose assets are controlled by the debtor"; and (iv) a "person who operates the debtor's business under a lease or other agreement or controls substantially all of the debtor's assets." § 19.40.011(2)(i)–(iv) .

Finally, insiders also include the debtor's "managing agent[.]" § 19.40.011(7)(v). The

latter term is not defined in the statute. Relatives are defined under the statute as anyone related within the third degree of

consanguinity "as determined by common law," spouses, and anyone related to spouses within the same degree. § 19.40.011(11). Adoptive relationships are included as within the degrees of consanguinity. Id.



B. Transfers Fraudulent as to Present and Future Creditors

There are two additional ways transfers can be fraudulent, both availale to present and future creditors. First, a transfer is fraudulent if made with actual intent to hinder, delay, or defraud the creditor. Second, a transfer is fraudulent if a transferee did not receive reasonably equivalent value for the exchange.

1. Actual Intent to Hinder, Delay, or Defraud

Any transfer that is made or obligation that is incurred is fraudulent as to existing and future creditors if made or incurred with "actual intent to hinder, delay, or defraud a creditor." WASH. REV. CODE § 19.40.041(a)(1). A court may determine actual intent by considering eleven nonexclusive factors: (1) whether the transfer was made or obligation was incurred to an "insider"; (2) whether the "debtor retained possession or control" of the transferred property subsequent to transfer; (3) whether the obligation or transfer was "disclosed or concealed"; (4) whether prior to the transfer or obligation, the debtor was "sued or threatened with suit"; (5) whether the transfer constituted "substantially all of the debtor's assets"; (6) whether the debtor "absconded"; (7) whether the debtor "removed or concealed assets"; (8) whether the debtor received consideration that had "reasonably equivalent" value to the value of the transferred asset or obligation incurred; (9) whether the debtor was or became insolvent soon after the transfer or obligation; (10) whether the transfer "occurred shortly before or shortly after" the debtor incurred a "substantial debt"; and (11) whether the debtor "transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor." § 19.40.041(b)(1)–(11).

"Reasonably equivalent value" is not defined for purposes of this section. See

§ 19.40.031(b) (section defining the phrase applies only for the "purposes of RCW 19.40.041(a)(2) and 19.40.051").

For what constitutes "insolvency," see Section I-A-1, supra at 1–2. For what constitutes

an "insider," see Section I-A-2, supra at 2–3. 2. Reasonably Equivalent Value

Any transfer that is made or obligation that is incurred is fraudulent as to existing and future creditors if the debtor made or incurred it "without receiving a reasonably equivalent value in exchange for the transfer or obligation" and one of the following two criteria are met: (i) the debtor "[w]as engaged or was about to engage in a business or transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction"; or (ii) the debtor "[i]ntended to incur, or believed or reasonably should have believed that he or she would incur, debts beyond his or her ability to pay as they became due." Wash. Rev. Code § 19.40.041(a)(2)(i)–(ii).

For what constitutes "reasonably equivalent value" for purposes of this provision, see

Section I-A-1, supra at 1–2.



C. Creditors' Remedies and Transferee Defenses

For actions against transfers or obligations, creditors may seek any of the following relief: (1) avoidance to the extent needed to satisfy their claims; (2) attachment of transferred assets or "other property of the transferee"; and (3) subject to equitable principles, injunctions, appointments of receivers, or "[a]ny other relief the circumstances may require." Wash. Rev. Code ; 19.40.071(a). A creditor may also levy execution on a transferred asset or its proceeds with court approval if he has obtained a judgment against the debtor. Id. at (b).

Transfers made with actual intent to delay, hinder, or defraud under Section

19.40.041(a)(1) are "not voidable" as against a good faith purchaser who paid "reasonably equivalent value," nor are they voidable against subsequent transferees or obligees. Wash. Rev. Code § 19.40.081(a).

To the extent a creditor may void a transfer, he may recover the lesser of the value of the

transferred asset (determined at the time of transfer and subject to equitable adjustment) or the amount needed to satisfy his claim. Id. at (b), (c). The creditor may recover from the initial transferee or a subsequent transferee, the latter only if not a good-faith transferee who "took for value[.]" Id. at (b)(1)–(2).

Even if a transfer is voidable, a good-faith transferee is permitted to obtain a lien on the

asset, enforcement of an obligation, or reduction in liability to the extent of the value paid. Id. at (d)(1)–(3).

Transfers under Sections 19.40.041(a)(2) or 19.40.051 are not voidable if they are: (1)

due to lease terminations on debtor default pursuant to lease or other law; or (2) pursuant to enforcement of security interests under UCC Article 9. Id. at (e).

Transfers to insiders under Section 19.40.051(b) are not voidable: (1) "[t]o the extent the

insider gave new value to or for the benefit of the debtor after the transfer was made unless the new value was secured by a valid lien"; (2) if the debtor and insider each made the transfer in the ordinary course of their business or financial affairs; or (3) "[i]f made pursuant to a good-faith effort to rehabilitate the debtor and the transfer secured present value given for that purpose as well as an antecedent debt of the debtor." Id. at (f).

D. Statute of Limitations

The statutory scheme contains a statute of limitations that depends on the type of fraudulent transfer. For transfers made with actual intent to delay, hinder, or defraud under Section 19.40.041(a)(1), a claim is extinguished after four years from when the transfer was made or the obligation was incurred, subject to a discovery rule of one-year from when it was discovered or reasonably could have been discovered if later than four years. Wash. Rev. Code § 19.40.091(a). For transfers to insiders under Section 19.40.051(b), a one-year statute of limitations applies starting with the date of transfer. Id. at (c). For all other fraudulent transfers, the statute of limitations is four years from the date of transfer or obligation. Id. at



(b). For determination of when a transfer is made or an obligation is incurred, see Wash. Rev. Code § 19.40.061.

Oregon Fraudulent Transfer Overview ORS Chapter 95 contains the provisions of the Oregon Uniform Fraudulent Transfer Act.

Under the Uniform Fraudulent Transfer Act, a creditor may set aside a fraudulent transfer or attach the transferred asset if it is able to prove the transfer was fraudulent. ORS 95.260. A fraudulent transfer is essentially one that was made by a debtor: 1) with actual intent to hinder, delay or defraud a current or future creditor; or 2) the transfer was made without receiving adequate consideration in return and the debtor: a) intended to engage in a business transaction for which the debtor would have insufficient assets to undertake; or b) knew or reasonably should have known that the debtor would incur debts beyond its ability to pay. ORS 95.230.

II. INVEST IN / OWN EXEMPT ASSETS Washington

Many provisions of Washington's Uniform Fraudulent Transfer Act are determined by reference to "assets." See, e.g., Wash Rev. Code §§ 19.40.011(12) (definition of transfer is made by reference to disposition of an "asset or an interest in an asset"); 19.40.021(a)–(e) (insolvency determined by starting with the debtor's assets); 19.40.031(b) (reasonably equivalent value requirement satisfied if asset purchased pursuant to regular foreclosure proceedings or pursuant to deed of trust).

The definition of "asset" under the statute expressly excludes: (i) "[p]roperty to the extent

it is encumbered by a valid lien"; and (2) "[p]roperty to the extent it is generally exempt under nonbankruptcy law." § 19.40.011(2). "Valid lien" is defined as a "lien that is effective against the holder of a judicial lien subsequently obtained by legal or equitable process or proceedings." § 19.40.011(13).

The statute does not define or list examples of exempt property under nonbankruptcy law.

One property exemption under Washington law is the homestead exemption. Wash Rev. Code §§ 6.13.010–.240. Under those provisions, a homestead is exempt from attachment and execution up to $125,000. §§ 63.13.030, 63.13.070(1). However, the homestead exemption will not protect fraudulent transfers which funded the purchase of the homestead. Casterline v. Roberts, 168 Wash. App. 376, 386, 284 P.3d 743 (2012).

Certain insurance proceeds are also generally exempt from creditors. Disability

insurance proceeds "which are supplemental to life insurance or annuity contracts" are "exempt from all liability for any debt of the insured" as well as for beneficiaries' debts when the proceeds are paid. Wash Rev. Code § 48.18.400. Proceeds from life insurance with beneficiaries other than the insured are payable to beneficiaries "against the creditors and representatives of the insured," and the proceeds are also exempt from beneficiaries' debts. § 48.18.410(1). However, life insurance proceeds are not exempt to the extent anyone's



rights to proceeds "have been transferred with intent to defraud creditors" or to the extent that premiums were paid "with intent to defraud creditors[.]" Id. at (3)(b)–(c). Group life insurance proceeds are "not liable . . . to be applied . . . to pay any liability of any person having a right under the policy." § 48.18.420. Moneys paid from fraternal benefit societies are not "liable to attachment, garnishment, or other process . . . to pay any debt or liability of a member or beneficiary[.]" § 48.36A.180. Additionally, insurance proceeds on property which is exempt are "exempt from execution, attachment, and garnishment." § 6.15.030. Annuity payments are exempt up to $3,000 per month (or installment), except as to premiums paid "with intent to defraud creditors[.]" § 48.18.430(1)(a)–(b).

Certain retirement benefits are also exempt. Pension payments to city employees are

exempt from "execution, garnishment, attachment, or any other process whatsoever[.]" Wash Rev. Code § 41.28.200. Pension payments to firefighters and law enforcement officers are exempt from "execution, garnishment, attachment, the operation of bankruptcy or insolvency laws, or any other process of law whatsoever[.]" § 41.26.053(1); see also §§ 41.24.240 (volunteer firefighters); 41.20.180 (city police officers); 43.43.310 (state police). Also exempt are retirement benefits paid to public employees, § 41.40.052, state employees, § 41.44.240, employees in the judicial retirement system, § 2.10.180, judges, § 2.12.090, and teachers, 41.32.052. Pension payments from the federal government are also exempt. § 6.15.020. Furthermore, any employee benefit plan payments (including from non-qualified plans, IRAs, and Roth IRAs) are exempt. § 6.15.020(3); see id at (4); § 49.64.020. However, once payments have been distributed, they may be subject to creditors. See Anthis v. Copland, 173 Wash. 2d 752, 764–65, 270 P.3d 574 (2012) (once payment from pension plan was distributed to police officer, it was not protected from creditors).

Additional exemptions include: public assistance payments for child welfare,

§ 74.13.070, general assistance, § 74.04.280, and the elderly, § 74.08.210; burial plots, § 98.24.220; payments to victims of crime (with various limitations), § 7.68.070; unemployment benefits (except for child support), §§ 50.40.020–.040; wages (greater of 75% of disposable earnings or thirty-five times the federal minimum wage), § 6.27.150; workers' compensation, § 51.32.040; and medical and health savings accounts, § 6.15.020(3)–(4).

Also exempt are the following: clothing (but furs, jewelry, and personal ornaments are

limited to $3,500), § 6.15.010(1)(a); private libraries up to $3,500 and all family photos and keepsakes, § 6.15.010(1)(b); household goods, furniture, appliances, and yard and home equipment up to $6,500, with a $750 limit per item, § 6.15.010(1)(c)(i); other personal property up to $3,000 (including cash up to $1,500), § 6.15.010(1)(c)(ii); motor vehicles up to $3,250 ($6,500 for the community), § 6.15.010(1)(c)(iii); child support, § 6.15.010(1)(c)(iv); health aids for the debtor or his dependent, § 6.15.010(1)(c)(v); bodily injury up to $20,000, § 6.15.010(1)(c)(vi); certain farm equipment up to $10,000, § 6.15.010(1)(d)(i); libraries, office furniture, equipment, and supplies for physicians, surgeons, lawyers, clergymen, and other professional persons up to $10,000, § 6.15.010(1)(d)(ii); tools of trade up to $10,000, § 6.15.010(1)(d)(iii); and some tuition credits, § 6.15.010(1)(e). The exemptions listed in Section 6.15.010 do not apply to the purchase price of property, restitution for crime victims, tax levies on property, or claims of certain child support agencies. § 6.15.050(2)–(4), (9).



Spouses are not liable for the pre-marriage debts of their spouses, and separate property is exempt from the separate debts of spouses. § 26.126.200.

Oregon Even absent a fraudulent transfer, this is not a very useful or practical strategy in Oregon. The assets that are exempted from the claims of creditors in Oregon are limited in scope and absurdly limited in value. For example, the homestead exemption, which is unlimited in states such as Texas and Florida, only protects up to $40,000 of value in a single debtor's homestead, and up to a whopping $50,000 for two or more members of the same household. ORS 18.395. The exempt amount for an automobile is $3,000. ORS 18.345. Two potentially valuable exempt assets under Oregon law are life insurance policies and qualified retirement plans. ORS 743.046(3) exempts the cash value in a life insurance policy from the claims of creditors if the beneficiary of the policy is not the estate of the insured. The proceeds of a life insurance policy are exempt under ORS 743.046(1) as long as they are payable to a beneficiary other than the insured. The payment of premiums in a manner that constitutes a fraudulent conveyance will cause the amount of fraudulent premiums paid, plus interest, to be subject to attachment by creditors when the policy proceeds are distributed to the beneficiary. ORS 743.046(4). Annuity payments made to a debtor are also exempt from a creditor's claims under Oregon law, but only to the extent the payments do not exceed $500 per month. ORS 743.049. As long as contributions made to a qualified retirement plan are "permitted contributions," the amounts received from the plan pursuant to its terms will be exempt from the claims of creditors. ORS 18.358(2). Permitted contributions are essentially those permitted by the Internal Revenue Code, pre or post tax, as long as they are not subject to federal excise tax. ORS 18.358(1)(c). III. ENTITY PLANNING If the debtor has a business or investment assets that may subject him, her or it to the claims of creditors, a valuable asset protection technique may be to establish a limited liability entity and transfer the risky asset(s) into that entity. The entity could be a corporation (whether it is a subchapter C or S corporation for tax purposes will not impact its efficacy as a vehicle to limit the shareholder liability), a limited partnership or a limited liability company. Under Oregon current law, the limited liability company is the most convenient and flexible option in most instances. By transferring the risky asset or operations to the limited liability entity, the debtor should be able to effectively isolate any liability that may arise from that asset and the assets to which a creditor might attach would be limited to the assets of the entity owning the asset or performing the services. To best ensure that the liability of the entity is not attributed to its owner (shareholder/partner/member), it is important to pay attention to the existence of the entity as a separate being and to respect any necessary formalities, such as required annual meetings, voting and action by resolution. Of great, if not the most, importance is that the entity be the party to all



contracts, the owner sign on behalf of the entity and not personally, that separate bank accounts are maintained for the entity, and that the owner not treat the entity account(s) as a personal "pocketbook."

Domestic Asset Protection Trusts

We live in an era of unprecedented litigiousness where doctors, lawyers, accountants and business owners frequently become defendants in lawsuits seeking damages in the tens of millions of dollars. Clients concerned about these potentially devastating liabilities are increasingly inquiring about the efficacy of establishing an asset protection trust (“APT”) as a part of a comprehensive estate plan to provide a measure of protection for their family's core savings.

An APT is an irrevocable, self-settled spendthrift trust that protects a portion of an individual’s assets from creditors. Since the late 1970s, APTs have been formed by U.S. citizens in offshore jurisdictions including Bermuda, the Isle of Man, the Cook Islands, and various Caribbean nations. Until recently, no U.S. jurisdiction extended spendthrift protection to trusts in which the grantor had retained an interest, at least to the extent of such retained interest. APTs have now been authorized in eleven U.S. jurisdictions: Alaska, Delaware, Missouri, Nevada, New Hampshire, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah and Wyoming. This article will focus on domestic APTs, rather than offshore APTs.

Some commentators question whether APTs are ethical since their raison d'être is to protect a portion of the donor's assets from creditors and, at the same time, allow the grantor to retain at least a limited interest in the trust. The honest answer is that APTs present a conundrum in which the law must balance two conflicting objectives: free alienation of property and protection of creditor's rights. This article will focus on the essential elements of a valid APT and the process which must be undertaken to strike a proper a balance between these two competing objectives. I. ASSET PROTECTION TRUSTS GENERALLY

Although domestic APT statutes vary in their details, they all share some common elements:

• Transfer property to an irrevocable trust • Resident trustee from the state of trust formation • Specific incorporation of state law • Inclusion of a spendthrift clause • Grantor’s retained interests • Tail periods for extinguishing claims

Transfer to Irrevocable Trust The transfer of assets must be to an irrevocable spendthrift trust. It may be a direct transfer from the grantor to the trustee or may result from the grantor’s exercise of an inter vivos power of appointment under an existing trust.



Resident Trustee or Qualified Trustee The trustee is typically an independent individual, bank, or trust company resident in the state of trust formation. Some states (e.g., Delaware) permit an out-of-state co-trustee. The grantor must not serve as the trustee, but may serve as an investment advisor and may reserve a veto power over distributions. The trustee must maintain custody of some or all of the trust corpus, must maintain trust records, prepare fiduciary income tax returns, or materially participate in the administration of the trust.

Trust Protector Many APTs have a trust protector, a fiduciary who may veto distributions and investments or remove and replace the trustee. The trust protector adds an additional layer of checks and balances in the management of the APT. Incorporation of State Law The trust instrument must expressly incorporate that state’s law to govern the trust’s validity, construction, and administration. For example, any claim involving a Delaware APT can only be brought in that state’s court. Spendthrift Clause The trust instrument must include a spendthrift provision prohibiting the attachment or assignment of any beneficiary’s interest in the trust. Grantor’s Retained Interests The typical APT permits the grantor to retain the following defined interests:

• Discretionary distributions of income and/or principal • Veto power over distributions • Special testamentary power of appointment

However, the Delaware Act permits the following additional retained interests:

Mandatory right to trust income Income or principal from a Charitable Remainder Trust Unitrust distribution (up to 5%) Receipt of principal at the trustee’s sole discretion or pursuant to an ascertainable

standard Right to remove the trustee or investment advisor Right to serve as an investment advisor Use of real property under a Qualified Personal Residence Trust Not limited to individuals—corporations and partnerships may create an APT



Tail Periods There are certain “tail periods” that begin to run upon the grantor’s transfer of assets to the APT. At the expiration of the tail period, the enforcement of nearly all future creditors’ claims is barred. Claimants who bring suit within the relevant tail period must prove the existence of a “fraudulent transfer.” Most APT statutes provide that future creditors (those creditors whose claims arise after the trust was created) must bring their claim within 4 years from the date of transfer to the trust. Existing creditors (those creditors whose claims arose before the trust was created) must bring their claim within the later of 4 years from the date of transfer to the trust or 1 year after the creditor discovered (or should have discovered) the existence of the trust. Fraudulent Transfer A creditor who brings a claim within the relevant tail period must prove that the transfer to the APT was a “fraudulent transfer.” Fraudulent transfer or fraudulent conveyance provisions exist under both the federal Bankruptcy Code and state law. Most states have adopted a version of the Uniform Fraudulent Transfers Act. An existing creditor may establish a fraudulent transfer if the grantor made the transfer without receiving reasonably equivalent value in exchange for the transfer; and the grantor was insolvent at the time (or the grantor became insolvent as a result of the transfer). A future creditor may establish a fraudulent transfer if the grantor made the transfer:

(1) With the actual intent to defraud any creditor; or (2) Without receiving reasonably equivalent value in exchange for the transfer; and the

grantor: (a) was engaged in a transaction for which his remaining assets were unreasonably

small in relation to the transaction; or (b) intended to incur (or believed he would incur) debts beyond his ability to pay as

they became due. The first test is a subjective “badges of fraud” test. Relevant lines of inquiry include whether the grantor has been sued or threatened with suit, whether the grantor effectively retained control over the assets, whether the grantor transferred substantially all assets to the APT, and whether the transfer to the APT occurred shortly before or after the grantor incurred a substantial debt. The essence of this test is whether the grantor could reasonably have anticipated the future creditor’s claim upon funding the APT. The second test is a more objective test which calls for an examination of the sufficiency of the grantor’s assets in light of the circumstances at the time of the transfer. If a creditor successfully challenges a transfer to an APT as being fraudulent, the creditor can recover its debt, plus any costs and attorneys’ fees allowed by the court. The existence of a



fraudulent transfer as to one creditor will not inevitably invalidate the trust for all creditors. Each creditor must demonstrate as to its own particular circumstances that a transfer was fraudulent. Exempt Creditors For public policy reasons, two classes of creditors enjoy special status (except in Nevada and Utah) and are exempt from the provisions of APT statutes: (1) spouses and children and (2) existing tort claimants. These creditors may reach trust assets without regard to any tail period and without having to prove the existence of a fraudulent transfer.

Trust assets will not be protected against child support claims or claims for alimony or marital property asserted by one who was married to the grantor at or before the time of the transfer to the trust. Since one does not acquire the status of “spouse” under this exemption if the grantor’s transfer pre-dates the marriage, an APT is a discreet alternative to a pre-nuptial agreement. APT statutes do not insulate trust property from tort claimants (death, personal injury, or property damage) on or before the date of the transfer to the trust where the injury is caused (in whole or in part) by an act or omission of the grantor or by someone for whom the grantor is vicariously liable. Efficacy of Domestic APTs Although domestic APTs are becoming an increasingly common asset protection device, their effectiveness has not been thoroughly tested in U.S. courts. APTs may be vulnerable to being set aside in bankruptcy court or in accordance with an out-of-state judgment. Even so, the mere existence of an APT is likely to act as a significant deterrent to a prospective plaintiff weighing the heavy costs of litigation against the likelihood of successful recovery.

Bankruptcy Court

No state statute can protect debtors from conflicting federal law. Federal bankruptcy law supersedes state law under the Supremacy Clause of the US Constitution. Thus, a bankruptcy court sitting in Connecticut could set aside an Alaska APT as being contrary to the public policy of Connecticut.

Full Faith & Credit

The Full Faith and Credit Clause of the U.S. Constitution requires courts of each state to recognize judgments rendered by courts of another state. As long as the rendering court has proper jurisdiction and the judgment was not fraudulent, the other state court must recognize it and give it the full effect that such judgment would have had if rendered by the such state’s own court.



Jurisdiction

A creditor must proceed in a state court that has jurisdiction over some aspect of the trust (this does not necessarily mean the state in which the APT was settled). The court will either have personal jurisdiction over the trustee, grantor, or beneficiaries; or in rem jurisdiction over trust assets.

There are several ways to obtain personal jurisdiction over a trustee, grantor, or beneficiary:

• Domicile: Individuals are always subject to jurisdiction of courts within their

domiciles. • Long-Arm: Long-arm jurisdiction arises if the trustee or grantor has sufficient

contacts with the forum state. • Corporations: Corporations are subject to jurisdiction of courts in their state of

incorporation and any state in which they conduct business.

There are also several ways to obtain in rem jurisdiction over the trust assets. State courts have jurisdiction over all property within the state’s borders, including real property, bank and brokerage accounts, and shares of stock of corporations incorporated in that state. If a trust holds stock in many different corporations, its property may be subject to the jurisdiction of several states’ courts.

Enforcement of Judgment

If a creditor has successfully obtained a judgment from another state’s court, it must find a way to have it enforced against the assets of the APT. If the other state court’s jurisdiction is based on the situs of trust assets, that court could compel the surrender of assets by court order (attachment, garnishment, etc.), forcing the party in possession to convey the assets to the creditor. If the court’s jurisdiction is over the trustee or the grantor, but not over the assets, the court might issue an order against the trustee or the grantor. Otherwise, the creditor must seek enforcement of the judgment in the state where the trust assets are located. This judgment may be enforced under the Full Faith & Credit Clause and might authorize the turnover of trust assets located in that state. To avoid this result a practitioner might consider the use of a limited liability entity such as a limited liability company or partnership formed in the state in which the trust sits to hold the assets that would otherwise be owned directly by the trust. The trust would then own the entity, rather than the assets themselves, and it may be more difficult to find that in rem jurisdiction exists in another state.



Integration with Other Planning An APT is not a stand-alone device. Rather, asset protection planning is part of an overall wealth preservation and management process that includes investment advice, insurance planning, income tax planning, estate planning and wealth protection. Candidates for APTs include professionals; individuals exposed to lawsuits arising from negligence, intentional torts, and contractual claims; officers, directors, and fiduciaries; and real estate owners with exposure to environmental claims. II. TAX CONSEQUENCES RELATING TO APTS Federal Income Tax Treatment If the grantor of an APT retains the right to receive discretionary income and principal distributions, the trust will be a grantor trust. Grantor trusts are disregarded entities and all trust income, whether or not received by the grantor, is taxed to the grantor. However, if distributions to the grantor must be approved by an adverse party, it could be a non-grantor trust, insulating the grantor from tax liability. PLR 200247013. Gift Tax A transfer to an irrevocable trust is not automatically a completed gift. If the grantor retains certain limited powers of appointment, completed gift status and the resulting potential gift tax consequences can be avoided. PLR 200148028. A transfer to an APT is a completed gift if the grantor surrenders control over assets. However, the inability of the grantor’s creditors to reach assets negates retained control. PLR 9837007. Escaping Income Tax and Gift Tax. Two private letter rulings permit the grantor to escape both income tax and gift tax. In these rulings, the grantor was not deemed the owner of the trust due to the existence of adverse parties who exercised discretion in making distributions, protecting him from income taxation. The same rulings further held that the grantor did not make completed gifts to an irrevocable trust, due to the retention of a limited testamentary power of appointment. PLRs 200148028 and 200247013. Estate Tax Inclusion of the trust assets in the gross estate depends on the degree of control the grantor retains in the trust. A discretionary receipt of income or principal is not a retained interest in the trust, absent an understanding with the trustee, whereas other retained interests would compel inclusion in gross estate. §2036(a). The inability of creditors to reach trust assets negates the implied ability to revoke or terminate the trust. §2038(a).



III. CASE STUDIES

1. Dahl v. Dahl, Civil No. 090402989 (Utah Dist. Ct. Nov. 1, 2011) Facts:

The Dahls created an irrevocable family trust in 2002, into which they conveyed an interest in real property. Dahl v. Dahl, Civil No. 090402989, slip op. at 5 (Utah Dist. Ct. Nov. 1, 2011), available at http://www.assetprotectionbook.com/casedocs/dahl/dahl_sj_01nov11.pdf. The case was a divorce case which had been going on for "many years." Id. at 1. Kim Dahl was the plaintiff and C. Robert Dahl, as investment trustee of the trust, and Charles Dahl, the husband, were the defendants. Id.; see id. at 7. Distributions to beneficiaries were in the sole discretion of the investment trustee, subject to Charles Dahl's veto power. Id. at 7. Even payments to Dr. Dahl were committed to the absolute discretion of the trustee. Id. Claims: 1. Plaintiff sought a determination that the trust was null and void. Id. at 5. 2. Plaintiff sought a determination that she had an "immediate interest" in the trust. Id. at 6. 3. Plaintiff sought a determination that the trust was revocable. Id. at 8. 4. Plaintiff sought an accounting of the trust. Id. at 14. The Court's Analysis and Disposition of the Claims: The trust was not null and void.

Plaintiff did not provide the court with a legal theory to find the trust null and void. Id. at 5. Plaintiff did not allege any facts to show the trust violated public policy nor did she allege duress, mistake, illegality, or undue influence. Id. at 6. Plaintiff's allegation that the trust was revocable was insufficient to provide a basis for the court to conclude that the trust was void. Id. The court therefore granted summary judgment to defendants on this claim. Id. Plaintiff did not have an immediate interest in the trust.

Any distribution under the trust to plaintiff was in the sole discretion of the trustee and was subject to Charles Dahl's veto power. Id. at 7. Furthermore, even distributions to Charles Dahl were in the trustee's absolute discretion. Id. Because plaintiff had "no fixed right to receive any distribution," she had no immediate interest in the trust; thus, summary judgment was granted to defendants on this claim. The trust was irrevocable.

Under statute in Utah, an irrevocable trust may be modified or terminated only with the consent of the settlor and all beneficiaries. Id. at 8, citing UTAH CODE ANN. § 75-7-411 (2004). As Dr. Dahl and his children did not consent to modification or termination, the plaintiff would have no rights to the trust corpus if the trust was irrevocable. Id.i at 9.

If the trust was revocable, the plaintiff might have a right as a settlor. Id., citing UTAH CODE ANN. § 75-7-605(2). However, the statute conditions its application by stating it does not apply if "the terms of a trust expressly provide that the trust is irrevocable[.]" Id.

The trust expressly stated that it was irrevocable. Id. at 9–10 (citing trust section titled "Trust Irrevocable" which stated "[t]he Trust hereby established is irrevocable"). According to the court, the second sentence, which read "Settlor reserves any power whatsoever to alter or amend any of the terms or provisions hereof[,]" merely "preserves the rights of the settlor



granted by statute, to amend, alter or terminate the irrevocable trust." Id. at 10. This right was limited to termination or modification with the consent of all beneficiaries. Id., citing UTAH CODE ANN. § 75-7-411. The court also found no trust provision titled "revocation," "amendment" or "alteration." Id. at 11.

Based on the "paramount rule of construction" that trust language is controlled by the grantor's intent, and utilizing a "four corners" approach, the court found that the trust was clearly intended to be irrevocable. Id. Furthermore, "commentators are unanimous in noting that where there is a question of whether the settlor intended to reserve the right to revoke, a statement that the trust is irrevocable will control." Id. at 13, citing GEORGE G. BOGERT, ET AL., THE LAW OF TRUSTS AND TRUSTEES § 992 (Rev. 2d ed. 2005).

Plaintiff also argued that the settlor's right to veto distributions meant that the trust was revocable. Id. at 11. The court found no authority for this proposition. Id.

That at one point the trustee deeded property out of the trust to the settlor so the settlor could obtain a loan on the property, which was then deeded back to the trust, did not change the analysis. Id. at 12. It was within the trustee's absolute discretion under the trust to make distributions, including in-kind distributions, and it was within the settlor's right to reconvey property into the trust. Id. at 12–13.

Furthermore, the trust provision on choice of law stated that Nevada law would govern the trust document. Id. at 14. Utah respects choice of law and choice of forum provisions. Id., citing Innerlight, Inc. v. Matrix Group, LLC, 2009 UT 31, 214 P. 3d 854. Under Nevada law, express statements of irrevocability in trusts mean that trusts "shall be irrevocable for all purposes, even though the settlor is also the beneficiary of such trust." Id., quoting NEV. REV. STAT. § 163.560.

Ultimately, the court found the trust irrevocable under both Utah and Nevada law. Id. Therefore, the court granted summary judgment to defendants on this claim. Plaintiff had no right to an accounting as a discretionary beneficiary of the trust.

The court determined that plaintiff was "at best a discretionary beneficiary and Settlor." Id. at 14. Under the trust, discretionary beneficiaries were not entitled to an accounting. Id. at 15. By statute, beneficiaries are only entitled to an accounting "[e]xcept to the extent the terms of the trust provide otherwise[.]" Id., quoting UTAH CODE ANN. § 75-7-811(1)–(2) (2010). Since the trust provided otherwise, which was consistent with the statute, the plaintiff had no right to an accounting. Id. at 16. Therefore, summary judgment was granted to defendants on this claim. ***The Dahl v. Dahl case was appealed to the Supreme Court of Utah. Dahl v. Dahl, 345 P.3d 566 (Jan. 2015). Relevant Issue: Whether the trust was irrevocable. Holding: The Supreme Court held that the trust was revocable because Dahl reserved an unrestricted power to amend the trust. Court’s Analysis: The trust granted Dahl “any power whatsoever to amend any of the terms or provisions hereof.” The Court held that this language allowed Dahl to modify any and all trust provisions, including the provisions that make the trust irrevocable. Dahl, 345 P.3d at 580. The Court cited Mary F. Radford et. al., The Law of Trusts and Trustees § 993 (3d ed. 2008) which said:

Although the holder of a power to modify may not directly revoke the trust, he or she may do so indirectly by first modifying the trust by the insertion of a power to revoke and then exercising that power.



They also cited a previous ruling, In re Estate of Flake, where they held that a settlor’s unrestricted power to amend a trust included the power to revoke the trust. Dahl, 345 P.3d at 581. Further, the Court looks to the enactment of the Utah Uniform Trust Code that came after their decision in Flake. Id. The Comments to § 75-7-605 (which governs a settlor’s power to revoke or amend a trust), say that “[a]n unrestricted power to amend may also include the power to revoke a trust.” Id. Therefore, Dahl’s unrestricted power to amend leads the Court to hold that the trust is revocable under Utah law. Id. Fallout: This lead the court to allow Ms. Dahl to withdraw her contributions to the trust “with regard to the portion of the trust property attributable to either her separate property or any marital property.” Id. at 582–3. 2. Rush Univ. Med. Ctr. v. Sessions, 2012 IL 112906, 980 N.E.2d 45 (2012) Facts:

Sessions created an irrevocable trust in the Cook Islands in 1994 in which he was settlor and lifetime beneficiary. Rush Univ. Med. Ctr. v. Sessions, 2012 IL 112906, ¶ 3, 980 N.E.2d 45 (2012). Nearly all of his assets were placed into the trust, including a family limited partnership interest. Id. The trust allowed the trustees to make principal and income distributions for the settlor's "maintenance, support, education, comfort and well-being, pleasure, desire and happiness." Id. The settlor was also named as the "Trust Protector," and as such he was expressly empowered to appoint and remove trustees and veto any of their decisions. Id. Under the trust, the grantor could change beneficiaries at any time by will or codicil. Id. The trust contained a spendthrift provision. Id.

In 1995, Sessions irrevocably pledged $1.5 million to a university medical center for construction of a president's house, which the university subsequently built and named after him. Id. at ¶¶ 4–5. In 1996, Sessions sent the university a letter confirming his pledge, in which he agreed to make provision in his will or trust for the pledge. Id.

Sessions was diagnosed with cancer in 2005, and he blamed the medical center for not diagnosing it sooner. Id. at ¶ 6. As a result, he made a new will with no provision for the pledge. Id.

The university sued Sessions' estate to enforce the pledge. ¶ 7. At Sessions' death, his estate contained less than $100,000. Id. Claims:

The university sued under three separate theories among four claims. Id. at ¶ 9. Only one common law claim was at issue on appeal. Id. That claim was under the common law principle that "if a settlor creates a spendthrift trust for his own benefit, it is void as to existing or future creditors and such creditors can reach the settlor's interest under the trust." Id.



Procedural Posture:

The circuit court granted the university's motion for summary judgment on its common law claim, finding the trust void as against the pledge. Id. at ¶ 10.

The trustees appealed, arguing that the state's Fraudulent Transfer Act (FTA) superseded the common law remedy. Id. at ¶ 11. The appellate court reversed the circuit court's decision, finding the common law claim inconsistent with the UTFA. Holdings: 1. The FTA did not displace the common law rule. Id. at ¶38. 2. The university was a creditor of Sessions under the rule. Id. The Court's Analysis: Common Law Abrogation Analysis

Common law remedies in Illinois remain in force unless the legislature or court expressly repeals them. Id. at ¶ 13 (citations omitted). A court will generally not find an implied abrogation unless it is "necessarily implied from what is expressed"; even then, an "irreconcilable repugnancy" must exist between a statute and the common law rule at issue. Id. at ¶ 17 (citations omitted). Where the common law rule provides more protection than does the statute and is not inconsistent with it, the common law rule will be upheld as supplementing the statute. Id.

Illinois' FTA contains no express abrogation language; indeed, it provides that the "law relating . . . to fraud . . . supplement[s] its provisions." Id. at ¶ 18, citing 740 ICLS 160/11 (West 2006).

There was also no implied abrogation. Id. at ¶ 19. The FTA's purpose is "to protect a debtor's unsecured creditors from unfair reducations in the debtor's estate to which creditors usually look to security." Id. (citations omitted). The common law rule's purpose also protects creditors, but addresses only the situation where a grantor retains an interest in a self-settled trust with a spendthrift provision. Id. at ¶ 20. Furthermore, the common law rule applies even where no fraudulent transfer occurred. Id., citing RESTATEMENT (SECOND) OF TRUSTS § 156 cmt. a (1959).

The estate argued that the common law rule was inconsistent with the FTA because the former treats acts as fraudulent per se that the FTA considers nonfraudulent. Id. at ¶ 22. According to the court, the common law rule focuses on the interest retained whereas the FTA's focus is on fraudulent transfers. Id. Additionally, both the rule and the statute operate independently of one another in some circumstances, which negates an inference that the rule would make the FTA superfluous. Id.

The court also found two errors in the appellate court's finding that the common law rule's treatment of self-settled trusts as per se fraudulent interfered with the FTA's requirement that transfers be proved fraudulent: (1) the supplemental language in the FTA shows that it intended common law rules to supplement it; and (2) the rule's policy is not limited to fraud, but extends to people utilizing trusts to enjoy their lifestyles and keep creditors from reaching their assets. Id. at ¶¶ 23–24.

Furthermore, fraudulent transfer statutes and the common law rule coexisted in Washington for centuries. Id. at ¶ 25. This tended to negate any implied abrogation on the part of the legislature when it enacted the most recent FTA. Id.



Analysis Under the Common Law Rule The estate argued that the common law rule did not apply to it because the settlor died

before the university brought its claim. Id. at ¶ 27. According to the estate, upon the settlor's death, the rule does not allow creditors to reach trust assets "that could have been, but were not, distributed to the settlor during his life." Id., citing RESTATEMENT (SECOND) OF TRUSTS § 156. To this argument, the court found that a settlor's "interest" includes "all income and principal that could have been distributed to the settlor, even when the trustee exercises complete discretion over such distributions." Id. at ¶ 28, citing RESTATEMENT (SECOND) OF TRUSTS § 156(2). It distinguished between that situation and cases where settlors irrevocably commit assets to other beneficiaries, thus leaving only an income interest to themselves. Id. In the present case the settlor had an interest in income and principal, because he could replace trustees at will and veto their decisions. Id. The court also distinguished a Connecticut case where a settlor's interest in trust principal did not trigger for 20 years. Id. at ¶ 29, citing Greenwich Trust Co. v. Tyson, 129 Conn. 211, 27 A.2d 166 (1942).

Defendants also argued that creditors cannot reach assets under the rule that could have been distributed during his lifetime but were not before his death. Id. at ¶ 30. The court found "no conceptual difference" between a settlor favoring himself over creditors as compared with favoring his beneficiaries over his creditors. Id. It found "no sound reason" to find creditors' rights cut off at the moment of a settlor's death. Id.

In In re Morris, 151 B.R. 900, 906–07 (C.D. Ill. 1993), heirs of a settlor who put funds in a self-settled spendthrift trust argued that the debtor could not be forced to turn over funds in which she had no interest due to her death. Id. The district court there found that because the trustee could distribute the entire trust corpus to the debtor, the entire corpus was subject to creditors' claims. Id. The court in Sessions found Morris to be "almost exactly on point" with the facts of the case. Sessions, 2012 IL 112906, at ¶ 32.

In Morris, however, the creditor was a judgment creditor before the settlor's death, whereas in Sessions the university did not become a judgment creditor until after the settlor's death and the pledge was not due until death. Id. The estate argued that this difference meant that the university was not a creditor for purposes of the common law rule. Id. The court found that the rule is not limited to creditors who become judgment creditors prior to death. Id. at ¶ 33, citing Johnson v. Commercial Bank, 284 Or. 675, 588 P.2d 1096, 1100 (1978). In Johnson, the court found that "'creditors may reach such assets even after the settlor dies' because the placement of the funds into the trust is void as against existing and future creditors, and it is as if placement into the trust never occurred." Id., quoting Johnson, 588 P.2d at 1100.

Furthermore, a creditor's claim is "not defeated merely by the death of the debtor," and the remainderman's interest is subject to creditors' claims. Id. at ¶ 34, citing Deposit Guar. Nat'l Bank v. Walter E. Heller & Co., 204 So.2d 856, 862–63 (Miss.1967).

According to the court, the common law rule is also not dependent on an actionable claim arising during a settlor's lifetime. Id. at ¶ 35, citing In re Estate of Nagel, 580 N.W.2d 810, 811–12 (Iowa 1998) (where joint tortfeasers were killed in accident giving rise to claim, court rejected argument that obligations must have arisen during lifetime of tortfeasers). In Nagel, the "facts precipitating [the claim] occurred during their lifetimes". Id., quoting Nagel, 580 N.W.2d at 812.

In the present case, the court found Sessions to be a "debtor" and the university a "creditor" during session's lifetime. Id. at ¶ 36, citing BLACK'S LAW DICTIONARY 396, 433 (8th ed. 2004). Sessions "incurred an obligation to pay plaintiff money, even if it was to be paid at the latest upon his death as a debt." Id. As in Nagel, the facts precipitating the university's claim



occurred during Sessions' lifetime. Id. The rule thus applied to Sessions, and the university was allowed to recover against the trust. Id. at ¶¶ 36–38.

3. In re Huber, 493 B.R. 798 (Bankr. W.D. Wash 2013) Facts:

The debtor was a real estate developer who started having financial difficulties during the real estate collapse in 2008. In re Huber, No. 11-41013, slip op. at 3–6, 493 B.R. 798 (Bankr. W.D. Wash 2013). He created an Alaska Domestic Asset Protection Trust (DAPT) on Sept. 23, 2008. Id. at 5. The debtor was the trustor of the DAPT, and the trustees were his son Kevin, another individual,1 and the Alaska USA Trust Company (AUSA). Id. at 6–7. The trust beneficiaries were the debtor and his children and stepchildren. Id. at 7.

The debtor created an Alaska LLC (DGH) on Sept. 4, 2008, into which he transferred $10,000 cash and his interests in over 25 entities (including his personal residence and the residence of his disabled daughter). Id. at 6. The DAPT owned 99% of DGH (the debtor's son Kevin owned the remaining one percent). Id. After the transfers to DGH, the debtor retained personal ownership of only a few assets, including five percent of a professional building, worthless accounts receivables, and 50% of one LLC. Id. Only the $10,000 cash was actually in Alaska (in a CD), with the remaining assets physically situated in Washington. Id. at 7.

The trust made discretionary income payments to the beneficiaries of over $700,000 between 2009 and 2010 for, among other things, personal expenses of the debtor and his children, educational expenses of his children and grandchildren, and payments to the debtor's former spouse. Id. at 7. After the bankruptcy petition was filed, the trust made payments of more than $400,000. Id. at 8. The payments were approved by the debtor's son Kevin as trustee. Id. Kevin did not meet with AUSA representatives regarding distribution requests, and AUSA was not involved with trust asset preservation or protection. Id. (calling AUSA a "straw man"). The Court's Analysis and Disposition of the Claims:

The Bankruptcy Trustee (Trustee) moved for summary judgment on five claims, discussed below. The court granted summary judgment for the Trustee on three of the claims. Validity of Trust

Because Alaska recognizes asset protection trusts and Washington does not, the court first examined the choice of law issue, id. at 10, ultimately finding that Washington law controlled. Id. at 12–13. It then analyzed the trust under Washington law, and found that it was invalid under that law. Id. at 13 A. Choice of Law

In federal question cases, including bankruptcy, courts apply federal choice of law rules. Id. at 10, quoting Lindsay v. Beneficial Reinsurance Co., 59 F.3d 942, 948 (9th Cir. 1995). The Ninth Circuit follows the Restatement (Second) of Conflict of Laws (1971). Id., citing Liberty Tool & Mfg. v. Vortex Fishing Sys., Inc., 277 F.3d 1057, 1069 (9th Cir. 2002). Under the Restatement, a living trust is valid if it is valid under the laws of the state the grantor selects to 1 The other individual was named Amber Hines. Id. at 6. The debtor had a stepdaughter named Amber, id. at 7, but it is unclear whether they are the same person.



govern the trust if that state has a "substantial relation to the trust" and applying that state's law would not violate a "strong public policy" of the state with which the trust has its "most significant relationship." Id., quoting RESTATEMENT (SECOND) OF CONFLICT OF LAWS § 270(a) (1971). A state has a substantial relation to a trust when it is the state in which the trust is administered, the trustee's place of business or domicil is located, the trust's assets are located, the settlor is domiciled, or the beneficiaries are domiciled. Id. at 11, quoting RESTATEMENT (SECOND) OF CONFLICT OF LAWS § 270 cmt. b. (1971).

Applying the Restatement factors, the court found that Alaska was not the domicile of the settlor or beneficiaries, nor was it where the assets were located (except for the $10,000 CD), and it was the domicile of only one trustee, AUSA. Id. at 12. Washington was the domicile of the settlor, beneficiaries, other trustees, creditors, and the drafting attorney, and nearly all of the assets were located there. Id. According to the court, Alaska therefore had only a "minimal relation" to the trust, whereas Washington had a substantial relation to it. Id. The court also found that Washington had a long-standing strong public policy against self-settled asset protection trusts. Id. at 12, citing WASH. REV. CODE § 19.36.020; Carroll v. Caroll, 18 Wash. 2d 171, 175 (1943). As a result of these findings, the court disregarded the debtor's choice of Alaska law and applied Washington law to determine the trust's validity. Id. at 12–13. B. RCW 19.36.020

Under Washington law, transfers to self-settled trusts are void as against creditors. Id. at 13, quoting WASH. REV. CODE § 19.36.020. Because the DAPT was a self-settled trust, the asset transfers into the trust were void as against the debtor's creditors. Id. Therefore, the court granted summary judgment to the Trustee. Id. Alter Ego

The Trustee moved for summary judgment on its alter ego/"reverse piercing" claim to reach the debtor's assets inside the trust. Id. at 13–14. Bankruptcy courts apply the forum state's alter ego law. Id., citing Towe Antique Ford Found. v. I.R.S., 999 F.2d 1387, 1391 (9th Cir. 1993). Washington had not previously applied the alter ego doctrine in a trust context. Id. As such, the court had to determine how the state supreme court would rule on the issue. Id. Because the Trustee did not cite any Washington judicial decisions or law relevant to deciding the issue, the Trustee failed to carry its burden. Id. at 14–15. 11 U.S.C. § 548(e)(1)

The Trustee also moved for summary judgment on its fraudulent transfer claim pursuant to the Bankruptcy Code. Id. at 15. Under that provision, a bankruptcy trustee may avoid any transfer made within 10 years: (A) to a self-settled trust; (B) by a debtor; (C) who is a trust beneficiary; and (D) the debtor had actual intent to "hinder, delay, or defraud" an entity to which the debtor was indebted. Id. at 15–16, quoting 11 U.S.C. § 548(e)(1).

The only element that the debtor did not concede was the actual intent requirement. Id. Circumstantial evidence may be used to show actual intent. Id., citing Barclay v. Mackenzie, 525 F.3d 700, 704 (9th Cir. 2008). In determining whether a debtor had the requisite intent, courts consider "badges of fraud," which "give[] rise to an inference of intent." Id. at 16–17, quoting In re Roca, 404 B.R. 531, 543 (Bankr. D. Ariz. 2009). These badges include: (1) "actual or threatened litigation"; (2) transfers of "all or substantially all of the debtor's property"; (3) debtor insolvency or unmanageable financial situation; (4) a "special relationship" between a debtor and transferee; and (5) subsequent debtor retention of the property transferred. Id. at 17, citing Acequia, Inc. v. Clinton, 34 F.3d 800, 806 (9th Cir. 1994) (internal citations omitted).



Analying the badges, the court found that: (1) litigation was threatened at the time of transfer, including foreclosures and defaults; (2) the debtor transferred nearly all of his property (more than 71%) to the trust; (3) the debtor was forced to sell property on which sale he was unable to pay taxes, pressured his business partner to pay him money, had a "strangling" debt load, and had many unpaid bills; (4) the debtor had a special relationship to the trustee, as they were the same person; and (5) the debtor effectively retained the transferred property because all of his requests for distributions were granted, the sole person reviewing requests was his son (who was also his business partner), and he took income of more than $14,000 per month from the trust. Id. at 18–20. Because the badges all weighed in favor of the Trustee, the court found that the debtor had the requisite intent under the statute, and it thus granted summary judgment to the Trustee on the claim. 11 U.S.C. § 544(b)(1) and RCW 19.40.041(a)

The Trustee moved for summary judgment on a state fraudulent transfer claim pursuant to the Bankruptcy Code. Id. at 21, citing 11 U.S.C. § 544(b)(1). Under Washington law, "a transfer is fraudulent if the debtor acts with actual intent to hinder, delay, or defraud a creditor," or if it makes a transfer without "'receiving equivalent value in exchange[.]'" Id. at 21–22, quoting WASH. REV. CODE § 19.40.041(a)(1)–(2). Courts consider eleven "non-exclusive" factors: (1) "[t]he transfer or obligation was to an insider"; (2) "[t]he debtor retained possession or control of the property transferred after the transfer"; (3) "[t]he transfer or obligation was disclosed or concealed"; (4) "[b]efore the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit"; (5) "[t]he transfer was of substantially all the debtor's assets"; (6) "[t]he debtor absconded"; (7) "[t]he debtor removed or concealed assets"; (8) "[t]he value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred"; (9) "[t]he debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred"; (10) "[t]he transfer occurred shortly before or shortly after a substantial debt was incurred"; and (11) "[t]he debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor." Id. at 22, quoting § 19.041(b); Sedwick v. Gwinn, 73 Wash. App. 879, 886 (1994).

Applying these factors, the court found many of them met: the debtor was threatened with suit; the transfer was of substantially all of his assets; the debtor retained control over the transferred assets; as trustee and settlor, the transfer was made to an insider; the debtor received no consideration for the transfer; and the debtor made the transfers to avoid creditors. Id. at 22–23.

The debtor's denial of fraudulent intent was insufficient to raise an issue of material fact. Id. at 23. Furthermore, although he stated estate planning—not avoidance of creditors—was his intent in making the transfers, the court found estate planning was not mutually exclusive with intent to shield assets from creditors. Id. at 24.

Because the badges weighed in favor of the Trustee, the court granted summary judgment on this claim. Denial of Discharge

Under Section 727(a)(2) of the Bankruptcy Code, discharge is precluded if a "debtor, with intent to hinder, delay, or defraud a creditor has transferred, removed, destroyed, mutilated, or concealed property . . . within one year before the petititon date[.]" Id. at 24, citing 11 U.S.C. § 727(a)(2)(A)–(B). Denial of discharge under the provision is "construed liberally in favor of the debtor and strictly against those objecting to discharge." Id. at 25 (citation omitted).



Because the transfers took place more than one year before the petition date, the debtor created the DAPT pursuant to Alaska law and with legal assistance, the court was unable to grant summary judgment on this claim. Id. at 24–25.

The Trustee also claimed that the debtor wrongfully used net loss carry forwards, but the court found that the Trustee did not carry its burden of showing the requisite fraudulent intent. Id.

Also, the Trustee claimed that because the debtor failed to disclose his own loans to one of his business entities, the court should deny discharge under Section 727(a)(4)(A) of the Bankruptcy Code. Id. at 26. That provision states that discharge should not be granted if "the debtor knowingly and fraudulently, in or in connection with the case . . . made a false oath or account[.]" Id., citing 11 U.S.C. § 727(a)(4)(A). To prevail on that claim, a plaintiff must show “(1) the debtor made a false oath in connection with the case; (2) the oath related to a material fact; (3) the oath was made knowingly; and (4) the oath was made fraudulently.” Id. (citations omitted). The court denied the Trustee's motion for summary judgment on this issue because it failed to establish that the debtor intended to deceive creditors by failing to list his loans. Id. at 27. IV. ATTORNEY PROTOCOL FOR ESTABLISHING APTS Due to ethical constraints, as well as the potential for civil or even criminal liability under certain circumstances, attorneys must be extraordinarily cautious in accepting and counseling clients with regard to the establishment of an APT. It is imperative that attorneys be fully aware of the client’s financial and legal situation, which should be independently verified through due diligence procedures to uncover any existing, foreseeable or threatened claims. Due diligence involves an objective investigation of the client’s personal finances, business dealings, legal record and other relevant information. Attorneys should also perform an analysis of the client’s financial solvency. This analysis includes the preparation of a net worth statement reflecting all of the client’s assets, subtracting all debts, liabilities, and claims, and subtracting assets that are already protected from creditors’ claims under federal or state law (e.g., homestead, qualified retirement plans, insurance and annuities). There is no magic number or safe harbor percentage in the amount of assets that should transferred to the trust. However, a larger transfer of assets to the APT reduces the client’s remaining solvency and increases the likelihood of scrutiny. Many commentators and practitioners recommend transferring less than one-third (1/3) of the grantor’s net worth. The factors to consider include the dollar amount of assets transferred, the nature of the client’s business and professional activities, the potential source of any claims and any additional asset protection planning tools available to the client. The goal should be to leave sufficient wealth to satisfy existing and foreseeable creditors. Providing adequate reserves for such claimants diminishes the odds of a successful fraudulent transfer assertion.



Without the benefit of hindsight, it is impossible to determine what will be deemed an appropriate level of due diligence. Such determination will depend upon the specific facts and circumstances presented by each client. However, the potential consequences of a failure to conduct sufficient due diligence in planning for an APT warrants an abundance of caution. Conclusion The litigation explosion that manifested itself in the American economy during the later half of the 20th century shows no signs of slowing down. Nowhere is it written, however, that an individual must preserve his or her assets for the satisfaction of unknown future claims and claimants. With the enactment of state legislation expressly authorizing the establishment of domestic APTs, asset protection planning has entered a new era. APTs formed under the proper circumstances and with the requisite due diligence can be expected to play an increasing role in the estate planning process for professionals and business owners.



Chapter 7

Ethical Issues for Advanced Trust and Estate Lawyers—Presentation Slides

alliSon martin rhodeS

Holland & Knight LLPPortland, Oregon

Chapter 7—Ethical Issues for Advanced Trust and Estate Lawyers—Presentation Slides




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Copyright © 2014 Holland & Knight LLP. All Rights Reserved

Ethical Issues for Advanced Trust and Estate Lawyers

May 2015

Allison Martin Rhodes, Holland & Knight

Our Program Today

Duties to Third Parties

Aiding and Abetting Breaches of Fiduciary Duty

Conflicts of Interest

Candor to the Tribunal

Testamentary/Diminished Capacity

Continuing Obligations 2



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Lawyer Jack and the Rich Family

Lawyer Jack meets with Grandma Rich, her adult grandsons, Greed E. Pigg and Seth Sloth, and Rich’s spiritual and financial adviser, Wanda Cash. During the meeting, Jack learns that Rich is very well to do but is not infrequently disoriented and that until Piggrecently insisted that she live with him, Rich lived for years with her only other living relative, a niece named Melissa Martyr. Based on what Jack hears and sees during the meeting, he comes to believe that Pigg was at least for a time a cocaine addict, that Sloth is a spendthrift and that Cash may be devoted to Rich but has no particular financial or investment expertise.

Day 1: Issues discussed at the first meeting includeThe potential appointment of Pigg and/or Sloth as trustees of a revocable trust for Rich; how to minimize Rich’s estate tax bill; and how much Martyr’s share of Rich’s estate should be reduced since she no longer takes care of Rich.

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Day 2: Jack, Rich and Cash Talk Further

Jack has Rich come back the next day, with Cash but without Pigg or Sloth. In Cash’s presence, Rich tells Jack that while she has doubts about yesterday’s discussions and also about whether Pigg and Sloth would, as her trustees, try to have her declared incompetent at the earliest possible date in order to get their hands on her money. Nevertheless, she says she is willing to proceed because she loves and doesn’t want to upset her grandsons.

Cash then suggests that Jack become trustee. Rich says that this is great because Jack could then hire Cash as the investment manager. Rich tells Jack that she does not mind that Cash lacks substantial skill in investments because someone who is that good as a spiritual adviser can just be trusted.

Day 3: The Work Begins

Jack asks Jill, his partner, to draw up the trust documents and also to draw up a bill of sale under which a portion of Rich’s property will be sold to Pigg and Sloth at bargain prices. The documents do not state with clarity who Jack and Jill do and do not represent.

The documents do, however, designate Jack as trustee. Jack explains that no one should worry about this because he will take care of everyone.



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Further Events

The documents are signed as drafted. Portions of Rich’s property are then sold to Piggand Sloth at bargain basement prices. In addition, Jack becomes trustee, declares Rich incompetent and then uses Cash as investment adviser.

Jack eventually represents Wanda Cash in setting up an LLC for off shore resort investment and the yacht. The advisor uses that LLC to “invest” all of Rich’s assets during the late stages of her life.

Who is the Client?

• Who are/were Jack’s clients?• An attorney-client relationship is

based on the reasonable subjective belief of the would-be client. Lawyers must therefore be vigilant to avoid unintended clients through non-engagement letters/emails, through updated notices when circumstances change and through avoiding giving even benign advice to nonclients.

Also known as “who wants to be a plaintiff?”



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The Attorney-Client Privilege

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Which conversations are confidential and or privileged and why?

The first meeting with all the family (Pigg, Sloth, and Cash)?

The second meeting with Cash?

Any of the meetings as asserted by one of the grandsons?

Conversations pertaining to the LLC, offshore investments and the yacht?

Does the lawyer have any duties to third parties?

• Split of authority re duties to third-party beneficiaries of an attorney-client relationship

• 34 states provide a cause of action for legal malpractice brought by beneficiaries for errors in estate planning that void an intended gift .

• This is not to say that all lawyer duties (such as care, loyalty, confidentiality etc) are enjoyed by beneficiaries. Authorities vary on this question.

• But lawyers can’t lie.

• RPC 4.3: dealing with unrepresented parties:

In dealing on behalf of a client with a person who is not represented by counsel, a lawyer shall not state or imply that the lawyer is disinterested. When the lawyer knows or reasonably should know that the unrepresented person misunderstands the lawyer’s role in the matter, the lawyer shall make reasonable efforts to correct the misunderstanding. The lawyer shall not give legal advice to an unrepresented person, other than the advice to secure counsel, if the lawyer knows or reasonably should know that the interests of such a person are or have a reasonable possibility of being in conflict with the interests of the client.”



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Spencer v. Barber, 299 P.3d 388 (N.M. 2013)• Client is driving car when accident occurs killing client’s daughter and infant

granddaughter. Lawyer represents client in wrongful death suit for death of daughter and granddaughter.

• Surviving father/grandfather is statutory beneficiary, but lawyer did not represent him.

• Lawyer received settlement offer from defendants and asked father/grandfather for release of claims in exchange for certain sum. Lawyer makes clear he is not representing father/grandfather. Lawyer and father/grandfather reach agreement of $20,000.00

• Father/grandfather reneges on agreement after lawyer settles with defendants for $900,000.00 and countersues for malpractice, alleging lawyer owed him duty as statutory beneficiary.

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Spencer v. Barber, 299 P.3d 388 (N.M. 2013)• Rules of Professional Conduct were relevant when ascertaining the scope of the duty

owed by the attorney to the personal representative in a wrongful death action and how a breach of that duty may have harmed a statutory beneficiary.

• “There can be no other purpose of an attorney-client agreement to pursue claims for wrongful death than to benefit those persons specifically designated by the Act as statutory beneficiaries. We conclude therefore that … the very nature of a wrongful death action is such that we will imply in law a term in every agreement between an attorney and personal representative that the agreement is formed with intent to benefit the statutory beneficiaries of the action.”

• Attorney owed duties to beneficiary and could not resolve conflict of interest by merely informing father/grandfather that he represented mother/grandmother. Conflict of interest arose when client informed attorney that father/grandfather was not entitled to any portion of proceeds due to alleged abandonment of daughter.

• Lawyer could have represented mother/grandmother through settlement with defendants. Who was entitled to proceeds thereafter should have been handled separately.

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Lawyers with Multiple Roles• Lawyer as fiduciary.

which rules apply?• Lawyer or firm as both fiduciary and fiduciary’s counsel.

– Conflicting fiduciary duties.– Higher fees (?)– Client conflict of interest rules apply.

• Lawyers as beneficiaries.• Conflict under RPC 1.7(a): there is a significant risk that the representation of one or

more clients will be materially limited by the lawyer's responsibilities to another client, a former client or a third person or by a personal interest of the lawyer.

• Lawyers representing individuals who are both fiduciaries and beneficiaries.– ACTEC Commentary to RPC 1.2 recommends disclosure to other beneficiaries, separate

files and careful billing practices. • Lawyers representing more than one party (e.g. co-trustees, multiple beneficiaries, husband

and wife). – No ACP/confidentiality as between joint clients– No authority to advocate the interests of one client over the other – unanimous directives

required– Duty of loyalty (conflicts) survive death

Conflicts of Interest

Be sure we are reading the lawyer rules.• Current client conflicts and former client conflicts RPC 1.7 and 1.9• Prospective client rules RPC 1.18What stakeholders must consent to a waiver and what is the waiver’s life span?• May be necessary to get beneficiary consent• Can a protected person waive a conflict?

– It is a question of informed consent which is defined in the professional responsibility rules and not other measures of competency.



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Duties to Prospective Clients

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RPC 1. 18 provides a prospective client is a person who discusses with a lawyer the possibility of forming a client-lawyer relationship.

Even when no client-lawyer relationship ensues, duties to a prospective client may arise if the prospective client discloses information to the lawyer.

Minimizing Duties to Prospective Clients

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To minimize duties to prospective clients in initial meetings:

Consider whether to consult a prospective client only after an estate planning questionnaire has been completed.

Consider whether to notify a prospective client, in writing, that no action is being taken on the prospective client’s behalf.

ACTEC Commentary to RPC 1.18 permits a lawyer to condition conversations with a prospective client on the person’s informed consent that information disclosed during the consultation will not prohibit the lawyer from representing a different client in the matter.



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Representing Multiple ClientsBefore representing multiple clients:

Consider whether conflict exists and can be waived. ACTEC Commentary on RPC 1.7 recommends that before accepting a representation involving multiple parties a lawyer may wish to consider meeting with the prospective clients separately, which may allow each of them to be more candid and, perhaps, reveal conflicts of interest

Discuss the potential for withdrawal if a conflict were to develop where the lawyer could not effectively represent both clients. Consider which of the clients, if any, the lawyer would continue and be able to represent if a conflict were to develop.

Memorialize terms of multiple representation in engagement letter.

When an existing client asks a lawyer to prepare a will for another person that will benefit the existing client– exercise caution. ACTEC Commentary to RPC 1.7 states that lawyer should caution both clients that existing client may be presumed to have exerted undue influence on the other client because the existing client was involved in the procurement of the will.

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Spence v. Wingate, 716 S.E.2d 920 (S.C. 2011)• Wife of comatose Congressman hires lawyer to advise her of rights in estate in light of

prenuptial agreement. Lawyer negotiates agreement between wife and Congressman’s children from another marriage.

• Congressman dies, and lawyer represents estate. Lawyer tries to convince wife to relinquish rights in Congressional life insurance policy. Wife asks lawyer to “put his hat back on” as her attorney, but he refuses.

• Wife retains interest in life insurance policy and sues lawyer for breaching his duty to her as a former client.

• Court held that lawyer breached duty to wife as a former client under RPC 1.9(a):

Lawyer who has formerly represented a client in a matter shall not thereafter represent another person in the same or a substantially related matter in which that person's interests are materially adverse to the interests of the former client unless the former client gives informed consent, confirmed in writing.

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Aiding and Abetting Breaches of Fiduciary Duty

• When the lawyer’s client (fiduciary or otherwise) is the bad actor, what may, must and can’t the lawyer do?

Rule 4.1 Truthfulness In Statements To OthersIn the course of representing a client a lawyer shall not knowingly:(a) make a false statement of material fact or law to a third person; or(b) fail to disclose a material fact to a third person when disclosure is necessary to avoid assisting a criminal or fraudulent act by a client, unless disclosure is prohibited by Rule 1.6.

RPC 1.6: A lawyer may reveal information . . .

(2) to prevent the client from committing a crime or fraud that is reasonably certain to result in substantial injury to the financial interests or property of another and in furtherance of which the client has used or is using the lawyer's services;(3) to prevent, mitigate or rectify substantial injury to the financial interests or property of another that is reasonably certain to result or has resulted from the client's commission of a crime or fraud in furtherance of which the client has used the lawyer's services.



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RPC 3.3 Candor to the Tribunal – the only MUST rule

(b) A lawyer who represents a client in an adjudicative proceeding and who knows that a person intends to engage, is engaging or has engaged in criminal or fraudulent conduct related to the proceeding shall take reasonable remedial measures, including, if necessary, disclosure to the tribunal.(c) The duties stated in paragraphs (a) and (b) continue to the conclusion of the proceeding, and apply even if compliance requires disclosure of information otherwise protected by Rule 1.6

Clients with Diminished/Diminishing Capacity

RPC 1.14 and express or implied authorization to make disclosures necessary to protect the client and the attorney client relationship, potentially including protective proceedings.• In whose name is it filed?• Can the lawyer be paid by another client to file such proceedings against the lawyer’s

own client?• Who does what after the case is filed?• Authority to act on the client’s behalf absent a fiduciary



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Recommendations for Diminished Capacity

ACTEC Commentary to RPC 1.14 suggests that a competent client consider executing a letter or other document that would authorize the lawyer to communicate to designated parties (e.g., family members, health care providers, a court) concerns that the lawyer might have regarding the client's capacity.

In addition, a lawyer may properly suggest that a durable power of attorney authorize the attorney-in-fact, on behalf of the principal, to give written authorization to one or more of the client's health care providers and to disclose information for such purposes upon such terms as provided in such authorization, including health information regarding the principal, that might otherwise be protected against disclosure by HIPAA.

If the client wishes the durable power of attorney to become effective at a date when the client is unable to act for him- or herself, the lawyer should consider how to draft that power in light of the restrictions found in HIPAA.

When Diminished Capacity and Crime/Fraud Collide• Attorney Grievance Comm’n of Maryland v. Coppola, 19 A.3d 431 (Md. Ct. App.

2011)

• Lawyer was asked by client to prepare estate plan for mother. Lawyer had telephone conference with mother, but mother was placed in hospital before signing new documents.

• Children pleaded with lawyer to allow oldest daughter to forge mother’s signature on documents. Lawyer notarized the false signatures on documents and requested his employees to sign as witnesses.

• After mother died, a dispute over property arose among children and forgeries revealed. Lawyer argued no violation of RPC 1.2(d) because the mother rather than children was his client, and he did not advise a client to commit fraud.

• Court held that where he was advising children on effect of the documents, children were also his clients.

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Beware of Creating Continuing Obligations

Svaldi v. Holmes, 986 N.E.2d 443 (Ohio Ct. App. 2012)

• Lawyer for elderly client drafter a power of attorney for the client which included language that holder of power attorney

shall also file an annual account by January 31st of each year and deliver it to Robert D. Holmes, attorney, or any attorney licensed in Ohio, designated by me or by the holder of this Power-of-Attorney for safe-keeping…

• The attorneys-in-fact did not file the inventory or accountings and stole large sums of money from the client.

• The client sued the lawyer, and the court held that including this clause created additional duties owed by the lawyer to the client. Lawyer was required to follow up with holders regarding requirements of power of attorney document.

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Any Questions?

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Documents

Advanced Estate Planning - Welcome to the Oregon State … · · 2015-11-14Advanced Estate Planning. Advanced Estate Planning ii ... F Planning turned upside down—income tax basis