Archive for the ‘Inheritance Tax’ Tag

Prince’s Million Dollar a Mile Mistake

Originally published in the Cedar Street Times

June 10, 2016

Unless you have been living under a rock, you have certainly heard by now that musician, Prince Rogers Nelson, passed away on April 21, 2016.  Unfortunately, he did no advance estate planning which means it is going to be an expensive, public, and litigious affair that will probably last for years.

I have seen estimates of his net worth in the media ranging from $250-$800 million.  Obviously, there is all the easy stuff to value – cash, stocks, bonds, real estate, and personal property.  But putting a value on things like his future royalties on music sales, video sales, his brand image, licensing of his lyrics or music to other artists to cover his songs, etc. is quite a task.

And what about the purported 2,000 or so unreleased songs he is said to have.  How many hits are in there?  Do you think an appraiser is going to sit in a room and listen to songs or read sheet music and put a value on each of them?  And once they come up with a dollar figure, then they have to discount it to the present value, so they would really need to consult their crystal ball for future interest rates, etc.

At one point in my career I worked with the family of a famous deceased musician, and I can tell you first hand that a lot of future value will be determined by how well his heirs maintain or expand the “Prince business machine” that will continue to promote his music and keep it alive, and keep people buying it.  And if the estate gets split up between multiple heirs that do not know each other, there will certainly be a decrease in value.  The last I checked, there was a sister, three half-siblings, and two people claiming to be his son, one of which is in prison, all vying for a piece of Prince’s estate.  So you might have to work with all of these people to buy the rights you need!

Prince certainly is not the first musician to have his estate valued, and there are accepted norms of how appraisers come to values, but I can tell you this much, whatever number they come to will not even be close to correct!  And there will certainly be a lot of negotiating between IRS appraisers and appraisers hired by Bremer Trust, the wealth management firm appointed to handle his estate.

And by the way, all of this is supposed to be done and estate taxes calculated and paid within nine months…in a perfect world.  The Form 706 United States Estate (and Generation-Skipping Transfer) Tax Return, which will list every single asset in his estate, (right down to the change in his pockets) with descriptions, values, and support for valuations is due January 21, 2017.  It is the mother of all tax returns.

The administrator of the estate can file a six month extension for the return, and the IRS can grant an additional year to pay the tax, but interest will start accruing on any unpaid tax after January 21st.  In situations with reasonable cause, the IRS can grant additional one year extensions for up to four and sometimes up to 10 years to pay the tax.  Although, they could also be assessed additional penalties.  The estate could also do an installment agreement for up to 14 years to pay the tax over time.

The extensions of time to pay, although not granted easily, are  designed to protect the interests of the heirs and the IRS.  With a massive estate and so many unknown quantities and litigation, you would have to have a fire sale to generate enough cash to pay the estate tax within nine months.

So how much estate tax will be paid?

The federal return will provide for a $5.45 million exemption for people dying in 2016.  That assumes that he made no lifetime gifts over the annual exclusion amount (currently $14,000 per person per year, and less in prior years).  It would be silly to assume someone of his wealth made no large gifts to individuals during his lifetime.  From what I have read about Prince, he probably made quite a few.  Any gifts he made in excess of the annual exclusion amounts would reduce his $5.45 million exemption.  For simplicity, though, let’s assume he made none.  So the first $5.45 million is tax free.  The rate of tax then slides from 18 percent on value in excess of $5.45 million to the top rate of 40 percent on everything over $6.45 million.  So for the first $6.45 million of his estate, a tax of $345,800 will be paid, and then 40 percent on everything over that.

Let’s assume his estate ends up being valued at $550 million and there ends up being $50 million in litigation and estate expenses leaving $500 million potentially taxable.  His federal estate tax would be $197,765,800.

Ahh, but Prince lived in Minnesota!  He was unfortunate enough to make his home in one of the 19 states (plus Washington DC) that have their own estate and/or inheritance tax.

Due to his residency the estate will also need to file a Form M706, the Minnesota equivalent of the federal Form 706. Minnesota will have a $1.6 million exemption.  The rate of tax then slides from ten percent on value in excess of $1.6 million to the top rate of 16 percent on everything over $10,300,000.  So for the first $10,300,000 of his estate a tax of $1,080,000 will be paid, and $1,600,000 for each additional $10,000,000.  So his Minnesota estate tax will be $79,432,000.

The Minnesota estate tax paid will fortunately be an additional deduction on the federal return.  So 40 percent of $79,432,000 will reduce the federal estate tax bill by $31,772,800, resulting in a $165,993,000 balance.

That will bring his total estate tax bill to $245,425,000, or roughly 49 percent, leaving his heirs with $254,575,000 to split up.

Besides all of the typical and sometimes fancy estate planning that could have been done to avoid costly litigation, and perhaps save tax through things like irrevocable life insurance trusts and other tricks up an estate planners sleeve,  I wonder if he ever simply considered setting up shop 45 miles away across the St. Croix river in Wisconsin?  It might have saved his estate $47 million – that is over $1 million per mile!

Although most people do not have $245 million estate tax bills for their heirs to worry about (or any estate tax at all), planning in advance and understanding the rules surrounding your tax and financial life is always important.  Sometimes even little things, learned early, can make a big difference.  And building a relationship with someone that can keep you on the right track is certainly of value.

Prior articles are republished on my website at www.tlongcpa.com/blog .

Travis H. Long, CPA, Inc. is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. Travis can be reached at 831-333-1041. This article is for educational purposes.  Although believed to be accurate in most situations, it does not constitute professional advice or establish a client relationship.

The Stale Trust Funding Dilemma

Originally published in the Pacific Grove Hometown Bulletin

November 17, 2011

 

The Stale Trust Funding Dilemma

By Kyle A. Krasa, Esq. and Travis H. Long, CPA

A very common Estate Planning technique for married couples is an “A/B Trust.”  The ideas behind the A/B Trust are to preserve the Estate Tax Exemption of the first spouse to die and to retain a degree of control over the deceased spouse’s share of the estate, protecting the deceased spouse’s beneficiaries from the whims of the surviving spouse.  Upon the death of the first spouse, the trust sub-divides into an “A Trust” (also known as a “Survivor’s Trust”) and a “B Trust” (also known as an “Exemption Trust,” a “Bypass Trust,” or a “Family Trust”).

Many surviving spouses who have A/B Trusts either do not realize that upon the death of the first spouse they need to physically split the assets between the A and B Trusts or consciously neglect to split the assets because they feel it’s unnecessary, expensive, or time consuming.  Occasionally, a surviving spouse with an A/B Trust will realize years after the death of the first spouse that the A/B split was never completed.  Alternatively, the surviving children of a deceased couple who had an A/B Trust where no A/B split was completed upon the death of the first spouse realize the estate was never settled.  In both cases, the A/B split should have been done upon the death of the first spouse and the task at hand is to figure out how to handle the situation.

The question becomes whether the assets should be split between the A and B Trusts now, correcting the mistake of neglecting to split the assets upon the first spouse’s death (known as “stale trust funding”), or whether the A/B provisions of the trust can be ignored.

Many people upon first blush will want to ignore the A/B provisions of the trust.  After all, trying to correct a mistake made many years ago will undoubtedly create additional legal fees, accounting and tax preparation fees, time, effort, and complications.  It is much easier to sweep these problems under the proverbial rug.  However, there are many legal and tax issues that must be carefully considered before deciding to ignore what can be a significant problem.

First, the tax purpose of the A/B split is to preserve the first spouse’s Estate Tax Exemption.  If the estate is larger than one spouse’s Estate Tax Exemption, by not performing a stale A/B split, you will be forgoing perhaps hundreds of thousands of dollars in Estate Tax savings.

Second, the beneficiaries of the B Trust might be different than the beneficiaries of the A Trust.  If you ignore the A/B split, are you disenfranchising the B Trust beneficiaries?

Third, the Trustee has a fiduciary duty to carry out the terms of the trust and is thus legally required to perform the A/B split if that is what the trust dictates.  The Trustee could face serious legal consequences by ignoring the law.

Fourth, the trustee could be held liable for tax returns that were not properly filed.

Normally, an administrative trust tax return is filed for any income generated by the decedent’s assets between the date of death and the date the A and B sub-trusts are funded.  After that point, the A trust income gets reported on the surviving spouse’s 1040, and the B trust income is reported on a form 1041 tax return each year going forward.

What happens when the funding is not done for years?  Most people in these situations continue to report all the income on their 1040s after their spouse passed away, as if nothing had happened. This is incorrect.

So, do you have to go back and file tax returns for the B trust for all those years?  The IRS generally takes the position that since the B trust was never funded, there are no tax returns needed for that trust.  Once you fund the trust, then you start filing returns for it, even if years later.  However, at the same time, the IRS views the decedent’s share of assets as having belonged to an administrative trust since the date of death – still waiting to be properly distributed.  This administrative trust should have had tax returns filed every year.  It is further complicated when those assets are used, retitled, sold, and mixed with other assets improperly.

There are generally three different approaches to solving the return filing problem.  The first is to go back and file tax returns for the administrative trust dating back to the date of death.  This is the safest route, but is probably the most expensive, and may be impossible depending on the records available.  You also have the problem of potentially amending all your 1040s that were not properly prepared as a result.

The second approach some practitioners use is to essentially file blank 1041s dating back to the date of death and include a statement with each return that all the income was reported on the surviving spouse’s 1040.  The problem with this is that the amount of tax owed, besides being paid on behalf of the wrong taxable entity, is rarely the same.  Filing blank 1041s clearly brings the issue front and center to the IRS, but, it could also bring closure to the issue.

The third approach some practitioners take is to not file any administrative trust returns for the past, and just start filing returns for the B trust going forward.  This approach has risks because required returns are never filed, and therefore the statute of limitations never begins.  The issue could theoretically pop-up at any time in the future without the appearance of being forthright.

It is clear there are many issues to consider in a stale trust administration.  If you find yourself in this situation as a surviving spouse or you think you may be the future beneficiary of funds from a stale trust, it would behoove you to seek qualified professional advice to determine if or to what extent you could be affected, and what your options are.  The most common reaction is to ignore it and hope it goes away or think someone else will deal with it later.  Unfortunately, if there is an issue, it almost always resurfaces upon the death of the second spouse, at which point it gets more expensive to handle, is more likely to cause fighting between beneficiaries, or creates an irreversible financial disaster for the beneficiaries.  Fortunately, there are solutions if you act today!

Prior articles are republished on our websites atwww.krasalaw.com and www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

KRASA LAW is located at 704-D Forest Avenue, PG, and Kyle can be reached at 831-920-0205.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

My Spouse Passed Away Years Ago – I Should be Filing Tax Returns for a Trust?

Originally published in the Pacific Grove Hometown Bulletin

November 2, 2011

There is a widespread misunderstanding that if you and your spouse had set up a living trust, nothing needs to be done when the first spouse passes away except remove the deceased spouse’s name from bank accounts and real estate deeds.  If you were under this impression, you may be leaving a big headache for your heirs and subjecting half of your estate to 35 or 55 percent inheritance tax, unnecessarily.  I am sure your heirs would be quite upset to learn you inadvertently “adopted” Uncle Sam, and are making the federal government one of the largest beneficiaries of your estate!

Most trust documents in California set up for married couples have a traditional “A-B” trust formula.  Due to community property laws, typically half the assets belong to each spouse no matter who earned them or whose name is on the account or deed.  Assuming the husband passes away first, the wife’s half goes to the A trust for her to do as she pleases, and she reports all income related to these assets on her personal 1040/540 tax returns.  The husband’s half goes to the B trust.  The husband typically gives his wife the right to use the income generated by the assets in his B trust, and if she does not have enough income from her other assets, she can dip into its principal for her health, education, or maintenance.

The B trust is special because the wife generally has limited control over where those assets go when she passes away.  The husband typically determines this in the trust document – after all, it was his half.  As a result of her limited control, she is not considered the owner of the B Trust assets and they are not included in her taxable estate when she passes away!  Starting in 2013, the estate tax exemption reverts back to a measly $1 million; in California, that might be the value of the family home!  In order to get this special tax-exempt treatment, the B trust needs to be “funded” (assets properly divided and retitled to new accounts), and you have to file 1041/541 tax returns for it each year thereafter.

Estate taxes aside, the other significant reason to properly set up the B trust and file returns is “remainder beneficiaries.”  These are the people or organizations the husband said would receive the remaining assets in the B trust upon the wife’s passing.  Any of these beneficiaries could sue her if she does not segregate the assets and properly follow the terms of the B trust.  This is often important if there are children from two marriages, or the deceased spouse wanted to make sure mom did not remarry and give all the money to the new spouse instead of his own children.

A final reason is that the IRS can care as well.  Most people that fail to fund and file returns for the B trust, treat all the assets as their own, and report all the income on their personal tax returns.  The overall tax is never exactly the same compared to filing 1041s even if income is supposed to go to the surviving spouse.  Another problem is that capital gains typically do not go to the surviving spouse and are taxed to the trust (although at similar rates).  A hard line auditor could say, “Yes, you paid tax, but the trust did not.”

If you failed to fund your B trust, confront the issue by seeking competent professional advice so you can determine if you need to do something and what your options are.  If there is a potential impact, it will surely resurface in your estate.  If it is not addressed before you pass, it will either get more complicated/expensive to handle or create an irreversible consequence.

In the next article I will expand on this by discussing the tax aspects of “stale” trust funding.  Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

Spouse/Parent Passed Away? Consider “Portability” Due to New Laws

Originally Published in the Pacific Grove Hometown Bulletin

October 19, 2011

If your spouse passes away in 2011 or 2012 (or you have a parent that is in this situation), you need to understand and consider the tax concept of “portability,” otherwise it could potentially cost the heirs dearly.   Last month, the IRS released forms and guidance for the 2011 Form 706 – United States Estate Tax Return requiring anyone who wants to reserve a future benefit through portability to file an estate tax return, even if you will owe no estate tax. This could affect people with estates valued as low as $1 million.  IRS news release IR-2011-97 states, “The IRS expects that most estates of people who are married will want to make the portability election, including people who are not required to file an estate tax return for some other reason.”

You may recall the news buzz last year surrounding Congress’ inability to act which led to no estate tax in 2010 – the impossible happened in the eyes of estate and trust attorneys and tax professionals when the estates of several billionaires such as George Steinbrenner paid no estate tax!  When Congress finally took some action after the fact, they could not undue what was done, but they did pass some laws which affect 2011 and 2012 by providing a $5 million estate tax exemption to each spouse.  They also created a new concept that says any unused portion of the first spouse’s exemption could be saved, and used in the surviving spouse’s estate.  This would give the surviving spouse an even higher exemption (protection from paying death taxes).  It also adds protection to people who simply failed to do proper estate planning.

Complications arise because the estate tax exemption will revert to $1 million in 2013 with a 55 percent tax rate.  This means that 55 percent of everything in your taxable estate over $1 million will go to the federal government unless democrats and republicans can actually agree “millionaires” should retain more of their estate during a time when the government desperately needs money.  Yikes!  Certainly you want to avoid this confiscatory tax if possible.

Let us assume you filed a Form 706 when the first spouse passes in 2011 or 2012 simply for portability of the unused exemption to the second spouse.  Technically, portability is set to expire at the end of 2012, but there is discussion that this new concept will be preserved or “grandfathered” to those who file 706s for 2011 or 2012.  If that is the case, then even if the estate tax exemption remains at $1 million, you would have available all the unused exemption from the first spouse’s passing.  This could be a massive benefit.  Assume the second spouse’s estate is worth $1.5 million.  They would pay $275,000 in tax (1,500,000 – $1,000,000 exemption = $500,000 taxable * 55%).  Of course if they had filed the 706 and preserved $500,000 or more of unused exemption from the first estate they would pay $0 tax.

The problem is, we do not really know what is going to happen, and we can only make educated guesses.  Although they are not simple filings, the cost of preparing a 706 in this situation should be thought of as an insurance policy against estate tax: By comparison, a small cost with potential huge savings.  Be aware that many tax professionals have not cultivated a strong interest in preparing this less frequently filed return.  You have nine months from the date of passing to file a 706 and you can obtain a six month extension.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.