Over the last year, Congress, the courts, and the IRS have developed habits that are likely to impact tax and estate planning. Here are a few:
Trust Administration Documentation vs. Reality
Reality matters. The courts and the IRS continue to focus on the actual operations of entities rather than the records or documentation. Take Webber v. Commissioner, for example. In that case, a trustee created an offshore, private-placement life insurance trust to distance himself from his assets and avoid having to pay income and estate taxes. The trust was thorough and accurately documented. However, despite the legitimacy of that documentation, the court found that the trustee still had serious and substantial control over his assets and was therefore still responsible for paying the taxes. To make their decision, the courts invoked the investor control doctrine, which states that a taxpayer with significant control over his or her assets—regardless of the accounts in which they are placed—is responsible for paying the taxes on those accounts.
A similar conclusion was reached in the Wyly case, in which the courts found that a number of investment trusts were in violation of SEC regulations. Even though the trusts were well-drafted and well-documented, their SEC violation was due to the way the trusts were operated. The Wylys brothers, who set up the trusts, were deemed responsible for paying back not only the profits made with the trusts, but also their incurred tax savings. Another parallel case was Elkins v. United States, in which the IRS followed the same reality-based line of attack rather than one based on paperwork alone. In the Elkins case, the judge focused on whether or not a discount on fractional shares of artwork should be permitted. The defendants lost badly, so they are unlikely to make that mistake again.
The lesson here is that risk does not end with the drafting of a trust document. It is crucial to oversee the operation and performance of a trust—especially when it involves a nonprofessional trustee (such as a family friend or relation) or a corporate trustee unfamiliar with US trust procedures.
A trustee’s actions should be reviewed annually, whether they have offshore trusts or split interest trusts such as FLPs, GRATs, ILITs, or CRTs. This will help address any issues with IRC sections 2031 and 2036.
Valuations, Regulations, and Estate Planning
The IRS has lately opted to closely examine regulations and people’s compliance with those regulations rather than debating an expert’s valuation of an item or estate. In some cases, such as conservation easements (documents that limit future development on a specific property), regulations are impractical from a transactional point of view, but are still required to obtain the tax credit in the first place. This is also true with charitable donations. In many of these cases, demanding “adequate documentation” seems odd; grantors who are also trustees, for example, have to issue receipts to themselves. Still, though, failure to comply with these regulations can result in a disqualification of the donation.
When filing tax returns, step away from the regulations and use checklists to make sure all your points are covered, even if they seem redundant or make little sense.
New Burdens on Personal Representatives for Estates
Congress has also introduced a new burden on personal representatives (PRs) for estates. The new law says that PRs must now report the cost basis (how much the original buyer paid per share) to the beneficiaries of estates. This helps determine the tax basis, or the difference between that initial buying price and an estate’s current market value. The step reveals how much a beneficiary gained or lost in the transaction. Previously, beneficiaries and PRs were able to make their best (and presumably, most honest) guess about the cost basis of the estate.
Debate Continues on Estate Plan Taxes
Estate taxes will be an important part of the upcoming presidential election. On one hand, Democrat Bernie Sanders would like to see three things: the increase of tax rates, the decrease of exemption (the amount of money one can leave to an heir before being taxed), and the elimination of credits and deductions on estates. On the other hand, the Republican-dominated House and Senate continue to file legislation to eliminate estate tax completely. If a Republican candidate wins the presidential election and the party picks up two or three more Senate seats in 2016, it is quite likely that estate taxes will be taken away. Even if Bernie Sanders is elected, it is not likely that he will be able to secure the seats necessary to adjust estate taxes as he would like.
For over 140 years, the attorneys at The Erskine Company have served Massachusetts families by developing effective estate plans and providing trust administration and fiduciary services that protect family wealth while complying with Massachusetts and federal estate-planning regulations. Estates that file taxes or deal with tax-related entities need to be closely monitored. At least once a year, a legal professional should ensure that the estate plan complies with increasingly complex regulations. If you have questions about protecting your family wealth, estate planning, or trust administration, contact Erskine & Erskine today.