Death and Taxes Blog

You'd think that making a charitable gift under your Will or Trust would be an easy thing to do. But it's actually pretty easy to mess up. Back when I worked at a big law firm, I had to deal with the estate of a client whose Will left a large amount of money to a charity that didn't exist. A charity that, in fact, had NEVER existed. (Something like the "Pet Care League of Chicago.") This issue was made more awkward because the attorney who drafted the Will was very powerful within the firm. Needless to say, it took (me) a ton of time and effort to fix this issue.

A few observations or tips:

1. Find out the charity's actual name. A good way to do this is to call the charity, or at minimum check their website. If you call, make sure you do so anonymously (unless the client wants the charity to know of the gift).

2. Provide that payment should only be made if the charity is in existence at the client's death. If the client is concerned about charitable deductions, provide that the charity must also be a recognized 501(c)(3) organization under the Internal Revenue Code.

3. To limit (the gift) or not to limit? That is the question. Charities love "no strings attached" gifts. But some donors prefer to direct how their gift will be used. If there's a desire to direct, make sure flexibility is built in to the document. (If you want to leave the money to "Church of X, for their overseas travel fund," what happens if that fund doesn't exist upon your death?)

4. Consider whether you even want to leave the money in a Will or trust. Recognized charities don't pay income tax, so you and they can get a lot of bang for the buck if you leave retirement accounts to them. They pay no income tax on such accounts, whereas your kids or friends might pay a pretty hefty sum. If you have a 300K retirement account, would you rather have 300K pass to a charity, or have 200K pass to your kids (with the rest going to Uncle Sam)?

5. Likewise, consider a gift during your lifetime. Giving 300K as opposed to 300K when you die in 10 or 20 years means that you give much more -- the charity gets the 300K and the time value of money. You get recognition, if you want it (for instance, check out the goodies you get if you give over $10,000 to WFMT -- and know that this kind of thing is typically just the tip of the iceberg).

Want to make an estate planner cringe? Mention that you made a loan to a family member at a below-market interest rate (or, even better, a no interest loan). Why do estate planners hate this type of arrangement? The main reason is Internal Revenue Code Section 7872 (and the failure of most people to realize that these arrangements create income tax issues). That section imputes interest to a person who makes a loan at a below-market rate. For instance, if in January 2008 you made a $33,000 loan to your brother and his wife at 0%, Section 7872 would require us to:

1. Figure out the market interest rate for that loan. Assuming that the loan is considered short-term loan (less than 3 years), the January 2008 market rate would be 3.18%;

2. Deem you to have income equal to that amount (3.18% of $33,000, or $1,049.40); and

3. Deem you to have made a gift to your brother and his wife of the amount of deemed income ($1,049.40).

That's a lot of work for not a lot of money, isn't it?

Professor Beyer has a post (here) about why a bad economy is a boon for estate and gift planning.

The idea can be a fairly simple one. You believe stock in company X is undervalued, so you either give your shares in company X to someone (let's say your daughter), or you give your daughter money to buy shares. In either case, your daughter's buying power has increased because the market and company X's stock price have tanked. It's like the old broker's saying: "stocks are on sale." Hopefully, by the time your daughter needs the money, there will be a seller's market.

Let's take a more concrete example. You are convinced that GM is going to rebound. It's currently at $6.19 per share, and you think it will eventually (maybe in 5 years, maybe 10 or even 20) get back to $50.00 per share. You don't want to file gift tax returns, so you and your spouse decide to give your daughter shares of GM equal in value to your annual gift tax exclusion (currently $12,000 for each of you). That's 1938 shares each (or 3876 total shares). You make the gift, and GM goes to $50.00 per share. Your gift to your daughter is now worth $193,800!

Of course, the problem with making a gift like this in times like these is the psychology. It's already difficult for people to get over the idea that, if they make a gift, the gifted property is permanently gone. Add on the fact that many people feel like any current market conditions are somehow different than what we've seen in the past (this recession/depression will never end, house prices will always go up, etc.). The bold can make a lot of money at times like these, but are you really bold enough to act now?

One of my most well-received posts was this one, on "year-end gifting made easy."

Evidently the Federal Taxes Weekly Alert has calculated that the gift tax annual exclusion will go from $12,000 (right now) to $13,000 in 2009. Based on this, it seems like time for an update:

Next year the annual gift tax exclusion will increase from $12,000 to $13,000. The gift tax exclusion is the amount that you can give to as many people as you wish, per year, without paying gift tax or even needing to file a gift tax return.

If you are in a situation where you'd like to make gifts, the end of the year (and the start of the next year) is a good time to do it. Three quick, easy scenarios:

1. You and your spouse have three grown children. (Each child is married and has one child of his or her own.) You and your spouse each give $12,000 to each child on December 31, 2008 and $13,000 to each child on January 1, 2009. You have just given away $150,000 without having to pay gift tax or even file a return.

2. Same facts as in 1., but you also make the same gifts to each child's spouse. That's another $150,000 that you've given away without having to pay gift tax or even file a return.

3. Same facts as in 2., but you also make the same gifts to your three grandchildren. That's another $150,000 that you've given away without having to pay gift tax or even file a return.

What in the world is an UTMA account?

It's an account created for a minor. UTMA stands for "Uniform Transfer to Minors Act." Some states have UGMAs ("Uniform Gifts to Minors Act") instead of UTMAs. The terms UTMA and UGMA are interchangeable.

How is an UTMA account established?

Typically you set it up with a financial institution.

Who are the parties involved?

In addition to you (the person making the gift to the UTMA account) there's the beneficiary and the custodian.

What does the custodian do?

The custodian holds the property in the UTMA account for the benefit of the beneficiary. He or she invests the property, and can pay property out of the account for the beneficiary's benefit.

What's the advantage of an UTMA account over a guardianship?

The biggest benefit of an UTMA account is that you don't need to go to court in order to distribute property from the account. That saves time and money (although the downside is little or no court supervision). Also,...

Is the property in an UTMA account ever required to be distributed to the beneficiary?

Yes -- when the beneficiary reaches age 21, he or she gets all of the property in the account. This is another advantage over a guardianship (where property is turned over to the beneficiary upon reaching age 18).

Are there alternatives to an UTMA account?

Yes. The best alternative is creating a gift trust for the minor. Trusts are very flexible vehicles, and you can have provisions holding the property in trust way past the minor's 21st birthday.

Where can I read more?

The relevant statute for Illinois UTMA accounts is here.

1. I previously blogged about 529 plans, here and here. One of the nation's leading experts on these plans is Susan Bart, which whom I used to work. Ms. Bart has details here about some changes to Illinois law in this area. Most interesting to me is the creditor protection afforded to 529 plans.

2. This article talks about a Will contest and settlement involving former Massachusetts state representative Thomas Cahir. The scenario was (in my opinion) one of the most common: sibling vs. sibling. (The other we see fairly often is surviving second or third spouse vs. children of a prior marriage.) This quote, from one of the attorneys involved, is pretty accurate: "On the eve of trial the family decided to make a settlement, as is frequently the case in will contests." That's unfortunate -- it would be better for all parties to reach a settlement way before the eve of trial, but that's not human nature.

3. Evidently Hillary Clinton has come out with a tax proposal that involves keeping the estate tax exemption at its 2009 level ($3.5 million per person, which is potentially $7 million for a married couple). Here are a few details. Once I finish the article I'm working on, I'd like to put together a comparison of how the various candidates would handle the estate tax.

There's been a lot written about the gift tax ramifications of a fan who catches a "big" home run ball (like a player's 500th career home run ball) and then returns the ball to the player. Something I haven't heard anything about -- are there gift tax ramifications to a baseball player (or any famous person, really) giving an autograph? The thought crossed my mind after reading this article about a rare ball owned by David Wells of the San Diego Padres.

The ball, which Mr. Wells purchased for $7,000, originally bore the signature of Babe Ruth (holder of, among other records, the record for most career homers from 1921 through 1973). Mr. Wells later had Henry Aaron (who broke Mr. Ruth's record in 1974) sign the ball, and now has had Barry Bonds (who just tied Mr. Aaron) sign as well. The question for me is this: did Mr. Bonds' signature add more than $12,000 worth of value to the ball? I don't think it did, but you can see the possibility of an autograph (particularly one given by someone who doesn't often give autographs) would be worth more than $12,000. For instance: what's the value of an autograph by J.D. Salinger? Or an autograph by Thomas Pynchon?

A final word...

16. I've tried to give a number of practical hints on gifting over the years, focusing on things that can be done without an attorney. That being said, there are a lot of gifting situations that simply require the assistance of a professional, and maybe more than one professional:

-you are making gifts of a future interest

-you are making gifts that exceed the $12,000 annual exclusion amount

-you are involved in non-traditional gifting relationships -- loaning money to a child, selling property to a child for less than its fair market value, naming a child as a joint tenant, etc.

-the property being gifted has valuation issues. Obviously it's easy to figure out the value of a gift of $10,000 in cash -- it's $10,000. But what about assets like real estate, or a painting, or a minority interest in a partnership? These are far trickier, and the IRS is far more diligent about auditing in these cases.

11. The last major credit or exclusion from gift tax is called the "unified credit." It's found in Section 2505 of the Code.

12. The unified credit is currently $1 million, which means you can give away up to $1 million during your lifetime without owing gift tax. Note that this credit works in tandem with the annual exclusion amount. So, for instance, if you gave $100,000 to your daughter in 2007, you would get the $12,000 annual exclusion, and your unified credit would be reduced by only $88,000 (100 - 12).

13. The unified credit used to be, well, unified -- it was tied to the estate tax credit. In other words, there was one credit amount, which could be used during life or upon death.

14. In cases where you make gifts that exceed the annual exclusion, you'll still need to file a gift tax return, even if no gift tax is due. This is so the IRS can keep track of (and potentially challenge) the amount of your unified credit remaining.

15. With all this in place, would anyone ever need or WANT to pay gift tax? I don't know about "want," but in cases involving high net worth individuals, it may be better to make gifts now, and pay gift tax instead of estate tax. Obviously you lose with respect to time value of money (it's better to pay tax later rather than sooner), but you gain a couple of ways:

-You get property and its future appreciation out of the estate. The $1 million you give away today may be worth $2 million (or $3 or $10 million) when you die.

-The estate tax is calculated on the total value of the decedent's estate, including the money being used to pay the estate tax. That's not the case with the gift tax.

1. The gift tax exists as a "backup" to the estate tax, which is a tax on the value of property owned at death. If the gift tax didn't exist, for instance, you could give away all of your property before death, die with an estate of $0, and therefore owe no tax on the transfer.

2. What's a gift? A "gratuitous transfer." In other words, if you give me your house, that's a gift; if you sell me your house, that isn't. What if you sell me your house for less than fair market value -- is that a gift? It depends on intent. If you intended to make a gift of the difference between what I paid and the fair market value, then that difference is a gift. If I paid less than fair market value because I'm savvy, that's not a gift.

3. For the most part, when we talk gift tax, we're talking about federal law. More specifically, we're talking about Chapter 12 of Subtitle B of Title 26 of the U.S. Code (Title 26 of the U.S. Code is the Internal Revenue Code). Most states are like Illinois, and don't have their own gift tax (New York used to have its own gift tax, but got rid of it). North Carolina is one exception -- it still has its own gift tax.

4. The federal gift tax form is Form 709 (here is a pdf version of the 2006 form).

5. Are ALL gifts subject to gift tax? Not really. To simplify just a bit: you can give as much of your property as you want to your spouse or to charity, and those gifts won't be subject to gift tax. When we talk about the gift tax, our focus is really on gifts other than to your spouse or charity -- to kids and grandkids, nieces and nephews, etc.

Tomorrow: Credits and Exclusions

One of the themes running through the estate and gift tax laws is control.

Can I give money to charity but retain control of it?

Can I get a marital deduction for a gift to my spouse at my death while still retaining control of how the money is used?

Can I give money to my children without gift tax consequences while still retaining control of those gifts?

I want to focus on this last goal, and how it works in an ILIT scenario.

There is an annual gift tax exclusion. This amount is currently $12,000, which means you could write a check for $12,000 to as many people as you wish and not owe any gift tax (or even need to file a gift tax return). This exclusion is found in §2503(b) of the Internal Revenue Code. You will note that the language of this section specifically excludes "gifts of future interests in property." In other words, if you set up a trust for your child and contributed $12,000 to that trust, this gift wouldn't qualify for the annual gift tax exclusion because it is a gift of a future interest (i.e. your child doesn't have immediate access to the gift).

Enter the concept of the "crummey trust" (named after a family that went to court with the IRS over this issue). A crummey trust is simply an ILIT or other irrevocable trust that contains provisions allowing a beneficiary to withdraw all or a portion of any contribution to the trust within a given time period after the contribution is made (maybe 60 days?). If the withdrawal right isn't exercised, then the right lapses (disappears).

Giving the beneficiary this withdrawal right means that the beneficiary has indeed received a present interest in the gifted property, so the gift tax annual exclusion may be used. And of course, the idea is that a beneficiary will never (upon penalty of future disinheritance) withdraw the contribution, meaning it will remain in the trust, to be used to pay life insurance premiums or otherwise invested.

Two other points:

1. Notice of a contribution (and the right to withdraw all or a portion of that contribution) should be given in writing every time a contribution is made.

2. The language of the crummey trust must be drafted with care in order to avoid a situation where the beneficiary who doesn't exercise his or her right of withdrawal is deemed to have made his or her own (possibly taxable) gift to the trust.

NUTS AND BOLTS

12. The person setting up the 529 plan account (usually a parent) is called the account owner. The person who will be using the account to attend school is called the beneficiary.

13. One solution to the problem of overfunding a 529 plan is to change the beneficiary on the plan. If child #1 finishes her education and assets remain in the 529 plan account, switch the beneficiary of the account to child #2, to yourself, to your spouse, or to another relative.

14. Anyone can contribute to a 529 plan. So you can set up the plan and make contributions for the benefit of your children (a separate plan for each?), and your parents and your spouse's parents can also contribute.

ESTATE AND GIFT TAX

15. 529 plans interest both financial planners and estate planners. Why estate planners? Because of the gift element. Here's another tax advantage to 529 plans -- you can currently give up to $12,000 per year to any given person without any gift tax implications. The rules for 529 plans allow you to "front load" five years of these annual gifts into one big gift. So, you could kick off a 529 plan for each grandchild by giving $60,000 in year one. (Just be sure not to make any other gifts to the grandchild for the next five years.)

16. In most cases, if the account owner dies, the 529 plan account will not be included in his estate for estate tax purposes.

RESOURCES

17. Illinois has two main 529 plans: Bright Start Savings and Bright Directions.

18. The Bright Start Savings website is here.

19. Bright Direction is a newer program -- its website is here. As scary-looking Illinois State Treasurer Alexi Giannoulias puts it, "This plan allows your [professional financial] advisor the flexibility to build your college savings as aggressively or conservatively as you see fit."

20. Saving for College seems to be the most popular website for researching 529 plans.

INTRODUCTION

1. A 529 college savings plan is a tax-favored plan that allows you to save money for college.

2. "529" refers to a section in the Internal Revenue Code (here).

3. Each state has a 529 college savings plan (most states have more than one), and you can enroll in the 529 college savings plan of any state.

4. The 529 college savings plan discussed here (and hereinafter referred to as a "529 plan") differs from a prepaid tuition plan, which is referenced in the same section of the Internal Revenue Code. As its name suggests, a prepaid tuition plan allows you to lock in tuition rates at a state college.

5. With a 529 plan, you make deposits into an account. Those deposits are then invested (and hopefully grow). You can then use the money in your 529 plan account to pay for "qualified higher education expenses": tuition, room and board, mandatory fees, books.

ADVANTAGES

6. Tax advantage #1: Earnings on assets deposited into a 529 plan account are not subject to income tax.

7. Tax advantage #2: You don't pay income tax on assets withdrawn from a 529 plan account for qualified higher education expenses.

8. Tax advantage #3: In some states (like Illinois), if you enroll in a 529 plan in the state where you reside, you get a state income tax deduction for contributions made to the 529 plan.

DISADVANTAGES

9. Disadvantage #1: It may be hard to wade through all of the different state 529 plans, which have differing managers, fees, etc.

10. Disadvantage #2: Once you are in a 529 plan, investment options may be limited.

11. Disadvantage #3: This is the biggie -- the fact that if you withdraw assets from a 529 plan account for something other than qualified higher education expenses, you get a double whammy. The earnings portion of the amount withdrawn IS subject to income tax, PLUS there's an additional tax equal to 10% on this portion. Some states have additional penalties. The general problem here is in guesstimating how much you'll need to sock away. If I save too little, then I haven't taken full advantage of my 529 plan (and I'm on the hook for my daughter's education). If I save too much, what happens if she goes to a fairly inexpensive state school? Or decides to skip college altogether?

[Note: Edited to make it clear that the income tax and the 10% penalty apply only to the earnings portion of the amount withdrawn.]

According to the IRS, the annual gift tax exclusion will stay at $12,000 for 2007.  The gift tax exclusion is the amount that you can give to as many people as you wish, per year, without paying gift tax or even needing to file a gift tax return. 

Many older people add another person (usually a child) as a joint tenant on their bank account.  The question when the older person dies is, did he or she have "donative intent" with respect to the account?  Put another way,...

1. Did the older person intend to make a gift of the account to the other owner upon the older person's death?

OR

2. Was the other owner simply listed as an owner for convenience (maybe it was easier for the other person to write out checks, make deposits, etc.)?

The recent case of In re Estate of Shea (from Illinois' Second District Court of Appeals) includes a lot of nice language talking about how to deal with the above issue.  I've tried to cobble this language into different statements to (hopefully) create an easy 3-step process for addressing the disposition of joint accounts.

Step 1: The Presumption of a Gift (Burden of Proof #1)

As the parties agree, when a sole owner of a bank account adds an apparent joint tenant to the account, the law presumes that the original owner intends a gift.... [T]he relevant presumption is that the joint account agreement alone governs the ownership of a joint account, i.e., speaks the whole truth.

Step 2: Overcoming the Presumption of a Gift - Convenience Accounts

A party challenging the presumption can overcome it only by clear and convincing evidence.... [C]lear and convincing evidence that the joint tenants had any understanding other than that in the joint account agreement can defeat the presumption that the joint account agreement speaks the whole truth.

Illinois authority treats evidence establishing that a joint account was used as a convenience account as overcoming the presumption of a gift....   A convenience account is an account that is nominally a joint account, but is intended to allow the nominal joint tenant to make transactions only as specified by, and on behalf of, the account's creator....  The typical purpose of such an account is to allow the nominal joint tenant to pay the true owner's bills while the true owner is unable to do so.  These cases reasonably assume that a person does not intend to give away the funds in the very account he or she relies on to pay bills.

Step 3: Burden of Proof #2

[O]nce the party challenging the ownership of the bank account has presented sufficient evidence to overcome the presumption of a gift, the presumption vanishes.... However, the burden of proof remains on the party challenging the ownership.... [That is, o]n meeting that first burden, [the challenging party] has the second burden of showing by the preponderance of the evidence that the estate is entitled to the accounts. 

Last week I shared a true story about a tax-related cost of gifting your residence.  The author of one of my favorite law blogs, Deirdre R. Wheatley-Liss, also posted on this topic recently, and fleshed out why gifting can be such a bad idea.  Her post is here.

There are a lot of reasons NOT to give away your residence during your lifetime.  Many of those reasons have to do with relationship issues -- if you give your house to your son and then have a fight with him, will he kick you out? -- but tax concerns also play a part.  Here's a situation involving an acquaintance of mine -- the names and some details have been changed, but the main facts are accurate:

Joe Smith buys a house on the north side of Chicago in 1950 for $45,000.  In 2000, Mr. Smith makes a gift of the house to his only child, Marge, who lives there with (and cares for) him.  In 2005, Mr. Smith dies -- the house is appraised at $1.3 million. 

If Mr. Smith had owned the house at his death, Marge would have inherited it with a ("stepped-up") basis equal to the house's value at his death.  Marge then could have sold the house and paid no capital gains.  However, when Mr. Smith gifted the house to Marge, Marge assumed Mr. Smith's basis in the house -- let's say that's $45,000 (although improvements to the house may have increased that number a bit).  If Marge now wants to sell the house, she'll have a gain of around $1.2 million.  Some ($250,000) of that gain is excluded from taxation, but Marge will still have to pay tax on almost $1 million of gain.

One final point: gifting the house might have made more sense (at least from a tax perspective) if Mr. Smith had a bigger estate, since the estate tax rates are higher than the capital gains rates.  Excluding $1.3 million from your estate may be a good idea.  However, Mr. Smith had very few assets other than the house -- about $100,000 -- so his estate wasn't subject to estate tax at all.

I've written quite a bit about why it's a bad idea to give someone the gift of making them a joint tenant on your property -- here is my main post on the subject, which references an article from my website as well as an article from the You and Yours Blawg.

I'm sure Florida's politicians have the best of intentions, but the legislation discussed here is nonsensical.  The legislation "would keep a cap on property tax increases when a co-owner is added to a homestead property deed," an issue that "comes up most often when a parent puts a child's name on a deed to try to avoid probate court when the parent dies."  Adding a child or other individual as a joint tenant on your home is almost always a bad idea, and isn't something that the state should be encouraging or enabling.  The article mentions that  the legislation would cost the state $8.6 million per year in lost revenue.  The problem is that it's going to cost the people of the state of Florida much more than that when you consider the disputes that inevitably arise from these types of situations. 

Next year the annual gift tax exclusion will increase from $11,000 to $12,000.  The gift tax exclusion is the amount that you can give to as many people as you wish, per year, without paying gift tax or even needing to file a gift tax return. 

If you are in a situation where you'd like to make gifts, the end of the year (and the start of the next year) is a good time to do it.  Three quick, easy scenarios:

1. You and your spouse have three grown children.  (Each child is married and has one child of his or her own.)  You and your spouse each give $11,000 to each child on December 31, 2005 and $12,000 to each child on January 1, 2006.  You have just given away $138,000 without having to pay gift tax or even file a return.

2. Same facts as in 1., but you also make the same gifts to each child's spouse.  That's another $138,000 that you've given away without having to pay gift tax or even file a return.

3. Same facts as in 2., but you also make the same gifts to your three grandchildren.  That's another $138,000 that you've given away without having to pay gift tax or even file a return.

Law.com has an interesting story (here) about Alice Lawrence's lawsuit against the law firm of Graubard Miller.  Part of Ms. Lawrence's suit relates to the payment of legal fees to the firm for a probate litigation case involving her husband's estate, but there are also these allegations:

Ms. Lawrence wrote personal checks to the three Graubard Miller partners. [C. Daniel] Chill received $2 million. [Elaine M.] Reich received $1.55 million and [Steven] Mallis received $1.5 million.

According to the suit, they specifically told her not to pay this money to the firm, but to each of them individually. Chill allegedly instructed her to denote the payment as a "gift" on each check's memo line.

The following April, Chill allegedly told Ms. Lawrence she would need to pay gift taxes on the bonuses to the three partners or else their bonus payments would be dramatically reduced. She then paid $2.7 million in gift taxes to the federal government.

Maybe I'm missing something, but I can't think of a situation in which making substantial taxable gifts to your attorneys -- on the advice of those same attorneys -- is appropriate.