Estate Tax Returns from the Grave

Estate Tax is Coming Back. President Obama has signed a compromise agreement on a temporary extension of the Bush income tax cuts for a two year period. Part of the bill includes a return of the estate tax with a $5,000,000 exemption and a 35% rate for two years only. Prior to this new law, there was no estate tax in 2010. In 2009, there was an estate tax with an exemption of $3,500,000 at a maximum rate of 45%. Without this new legislation, then the exemption was on autopilot to be $1,000,000 per person with a maximum rate of 55% on January 1, 2011. The autopilot date has been postponed to January 1, 2013.

Opposition of Compromise. There was opposition in the House and Senate, but a tax compromise of a two year extension was able to pass and be signed by the President. However, the return of estate tax and whether the exemption should be less than $5,000,000 will be an issue in the 2012 elections for President and Congress. Since this is only a two year extension, this means that the estate tax exemption will be $1,000,000 on January 1, 2013 with a 55% rate unless there is another compromise. In order to stop this from happening, there must be 60 votes in the Senate for another compromise. In 2010, there was the pressure of raising taxes in a recession. If the past is an indication, there will not be a compromise next time and the estate tax exemption will revert to $1,000,000 on January 1, 2013.

Tax Increases Are Coming. We have written before that the estate tax would return because of the growing federal deficit. This tax proposal and unemployment extension may add more than $900 billion to the deficit for the next two years according to estimates. Part of the opposition to this two year extension of the Bush tax cuts was due to the large and growing federal deficit. Eventually, Medicare, Medicaid and Social Security and the interest on the debt are on autopilot to consume all federal revenues. There will have to be painful tax hikes in the future unless the costs of these and other programs are reduced more than what is now considered politically acceptable.


$5,000,000 Exemption. The impact on planning between a $5,000,000 per person exemption and a $1,000,000 exemption is very large. With home equity, a life insurance policy and retirement savings over a lifetime, it is common for a family who worked for the government or had a mid level position to have over a $1,000,000 estate. However, over $5,000,000 estates are not common and require that the person had an unusually successful business or had a $300,000 or higher annual salary over a long period of time. The $5,000,000 exemption removes the estate tax as a concern for only a small percentage of Americans. In addition, with the new portability provisions (more on this later), married people will more easily use their combined $10,000,000 exemption.

What to Do Now. If you will have an estate over $5,000,000, or if you are concerned that the $1,000,000 exemption and 55% rate will return January 1, 2013, what should you do now:

1. Make large gifts before the end of the year. Since there is no estate tax or estate tax exemption in 2010, it is a reasonable position to make large gifts in 2010 and not use up any of your future exemption from estate taxes. There is a large dispute over how this will be decided by the courts due to ambiguous language in the statute which provides for the expiration of the Bush tax cuts. Even if there eventually is a ruling that the rules for 2011 should apply to 2010, even thought the tax year and law was different during those two years, you are likely to come out ahead because you made a gift when dollar prices were depressed in 2010. If you give away something worth $800,000 in 2010, it may have a price tag of $5,000,000 in 2020 simply as a result of high inflation rates. Gifts in excess of your $1,000,000 gift tax exemption in 2010 would incur a 35% tax rate on gifts.

2. Make gifts to grandchildren or to trusts for grandchildren. Not only is there no estate tax in 2010, there is no generation skipping tax paid on gifts to grandchildren in 2010, even if to a properly designed trust for a grandchild. With the return of the estate tax in 2011 at a 35% rate, there will be a 35% tax on gifts to grandchildren under the generation skipping transfer tax (GSTT) over the $5,000,000 exemption for 2011 and 2012. The new law clarifies that you can make a gift to a trust for grandchildren in 2010 and pay no GST tax this year or in the future. This is done by reimposing the GST tax in 2010, but with a zero percent rate. You make gift to a trust just for grandchildren, you do not use any exemption from GST tax and therefore it is a taxable transfer in 2010, but since the tax rate is zero, you can make gifts to trust for grandchildren and not use up any of your $5,000,000 GSTT exemption. You only have until the end of 2010 to do this. You will be able to make GSTT gifts up to $5,000,000 in 2011 and 2012.

3. Discounting and GRATs not modified yet. There was concern that the use of discounts for family limited partnerships or through a grantor retained annuity trust would be curbed by the new legislation. They were not. However, when taxes will need to be raised in the future, these restrictions could be reconsidered.

4. Roth Conversion. You can convert your retirement plans to a Roth IRA in 2010. This can be an important tool of estate planning. If your financial projections are that you will not need to use the funds in your regular IRA during your lifetime, then if you convert it to a Roth IRA, you will not be required to take out any distributions during your lifetime and the funds in the Roth IRA will continue to accumulate tax free. If you retain the funds in a regular IRA or retirement fund, you will be required to take minimum distributions calculated to exhaust everything in your retirement account during your lifetime. Instead, if you leave your Roth IRA to your five year old granddaughter with a life expectancy of 105 years, then the granddaughter could take distributions over her remaining 100 year life expectancy and have one of the few accounts that are not subject to any of the high tax rates that are coming in the future. The downside is that you have to come up with separate funds to pay the taxes caused by the Roth conversion now.

Taxes Are Going Up. The debt commission recommends tax increases and drastic cuts so as to balance the budget by 2035. The 2010 tax rates and the two year compromise will probably be the lowest taxes you will see during your lifetime. Eventually, taxes will go up to pay for everything. Our future may look like what is happening is Ireland now where they have to have large broad based tax increases and large cuts in entitlement and spending.

It is Not Too Late. There still is time to take advantage of these end of the year planning opportunities. There are only a few days left to take advantage of the zero percent rate for gifts to grandchildren in trust in 2010.

Pursuant to U.S. Treasury Department Regulations, we are required to advise you that, unless otherwise expressly indicated, any federal tax advice contained in this document, including attachments and enclosures, is not intended or written to be used, and may not be used, for the purposes of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed in this document.


A Purchaser of a Foreclosed Property May Be a Victim of A Botched Foreclosure; Protect Yourself Against Defective Foreclosures

Bungled Foreclosures. There are many headlines and news reports about bungled foreclosures, major lender nationwide suspensions of foreclosures and governmental investigations of foreclosure fraud. You need to make sure that you are not a victim of this legal morass. 

Profits from Foreclosures. Buy low and sell high – is also a formula for making money in real estate. One way many people have bought low is to buy a property which has been foreclosed against. Often, a bank may be eager to get rid of a property that is costing it money that it cannot sell for top dollar because it needs a lot of work after it was trashed by the former owner or vandals. The investor buys the house, fixes it up and resells it for a profit or adds the house to their rental portfolio. Because of substantial fix up costs, cash requirements and holding periods costs, the investor usually needs to buy the property 40% or more under the market value.

Bob and Betty. Bob and Betty have been working for 20 years, but are nowhere near their dream of retiring with a large financial cushion. They went to a real estate seminar about how to make millions by buying foreclosure property and paid hundreds of dollars for books and tapes sold by the speakers. They follow the guidelines they learned, buy a foreclosure property, fix it up and are ready to put the house back on the market for a profit of over $50,000. After listing the property for sale with a realtor, they are served with legal papers from the former owner demanding that Bob and Betty turn over the house back to the former owner due to a defect in the foreclosure process. Bob and Betty lose the case, have to pay an attorney $50,000 to defend themselves and lose all of their investment and their savings of $100,000, sweat equity and lost weekends they put into the house. Their foreclosure dream has become a nightmare.
Foreclosure Legal Process. The buyer of a foreclosed property can have title problems if the legal procedure followed by the attorney overseeing the foreclosure was defective. There are many stories in the press now about defective foreclosures. In general, the law says you can’t take someone’s house unless you provide them the mandated notice, advertise the sale in the paper, have a proper auction and follow any required court filing procedures. Everyone can understand the heartbreak of someone who loses their home to a foreclosure and the law provides some protection to home owners against arbitrary foreclosures. Typically, after notice and advertisement, an auctioneer sells the property at a public auction and this process results in a legal transfer of title under state law to the new owner who made the highest bid at auction, all against the will of the foreclosed owner. Given the volume of foreclosures and bank loses, the lenders may have put the foreclosure legal work out to the lowest bidder and achieved defective results. Where a foreclosure does not properly transfer title to the auction imagesCAPEILPP.jpg” type=”#_x0000_t75″ o:spid=”_x0000_s1026″>buyer, the person who bought the property at the auction may never receive good title; the property may still be legally owned by the person against whom the foreclosure took place. This all depends upon a complex set of state rules. Each state has its own esoteric legal steps that have to be followed to legally transfer title through the foreclosure process. If the process was not followed correctly, the title of the buyer at auction could be defective and the auction buyer may be unable to pass good title onto the purchaser.
How Can This Happen? You as a buyer of a property which has been foreclosed, could have a loss of investment in the following cases:
1. You Didn’t Buy Title Insurance. You got a loan to buy the foreclosed property and the lender received title insurance but you did not buy title insurance for yourself. Title insurance is where a capital rich insurance company enters into a contract to guarantee that the title to the property is good. There are lender policies and buyer policies. For the buyer to be protected, the buyer has to buy their own policy. The buyer may not understand this or try to save money by only paying for a lender policy, mistakenly thinking they are protected by the lender insurance policy. A lender title policy protects the lender from loss, but not the buyer.


2. You Got a Quit Claim Deed. In the deed, there is generally a guarantee, called a “warranty” of title from the seller. If there is a title defect and you have a warranty deed, you have legal recourse against the seller if the seller had a title defect in their foreclosure. If there is no guarantee in the deed, you may have no recourse against the seller of a property with a defective title.


3. The Bank Went Bankrupt. The bank or large federally regulated institution went bankrupt and even though you had a warranty deed, you are now an unsecured creditor in a huge nationwide bankruptcy case headquartered in Delaware and you have to hire a Delaware attorney for a large fee to collect three cents of every dollar you invested.
4. Your Title Insurance Does Not Protect You. You go to settlement and pay for title insurance. You ask to read the title insurance policy to make sure that you are protected against a defective foreclosure on the property prior to signing the settlement papers. If you have a title insurance contract that says you own the property with no exceptions for the prior foreclosure and you lose the property due to a defective foreclosure, then the title company is supposed to pay you for the loses up to the dollar limit of the title policy. The settlement company says they will get around to writing up the policy a couple of weeks after settlement. The settlement company gives you a letter saying they will commit to issuing you a title policy with certain exceptions. The exceptions listed concern anything to do with the foreclosure. Unless the exceptions for the foreclosure are later removed, the title insurance contract will not protect you from defects in the foreclosure process. The problem is that you may have to go to settlement before the title company has even looked at the foreclosure paperwork to determine if there is a problem. All you get is a promise that they will issue a policy later and you have nothing in writing that they will guarantee there are no problems with the prior foreclosure. You may have only bought yourself a lawsuit if later the title company finds a problem with the foreclosure.
5. You Lost Your Fix Up Costs and Profit. Larry and Louise bought a title policy with no exceptions for the foreclosure with a limit of $150,000, the price they paid for the house. They put $50,000 of fix up and carrying costs into the house and are ready to sell it for $250,000. But, they lost the property due to a defect in the foreclosure process. The title company makes good on the insurance policy and pays Larry and Louise the policy limit of $150,000 and Larry and Louise are out $100,000.


How To Protect Yourself. In general, this has not been a likely problem in the past and in many cases will not be a problem today for many reasons even if there is a defect in the foreclosure. But, press reports indicate that the number of messed up foreclosures have dramatically increased. To protect yourself, obtain a copy of the title policy with insurance against foreclosure defects prior to the settlement. If you have this option, select a title company to do the settlement that you know and trust to thoroughly review the foreclosure record. If you expect a large profit, have a clause in your purchase contract that provides that your own lawyer must approve the foreclosure paperwork as a condition of going to settlement. This will focuses everyone’s attention on getting this taken care of prior to settlement.


Real Estate Problems. We have decades of experience working with investors in residential and commercial real estate and look forward to working with you.

Estate Plans that Fail to Protect Your Family; When Wills, Trusts, Powers of Attorney and Asset Transfers Are Not Enough

What is Estate Planning? Insurance companies, banks, financial planners and attorneys all advertise that they will help you with your estate plan. When we talk about estate planning, people are often confused as whether we provide financial or legal advice. Our name, Washington Wealth Counsellors, lends to this confusion. The answer: an effective estate plan is one that protects and provides for you and your loved ones now and in the future and distributes your property the way you want, when you want and how you want with the minimum of taxes and expenses. This requires the skills of lawyers, accountants, financial planners, insurance professionals and trust officers.

Sam and Sally. Sam and Sally come to us for an estate plan. During the interview we discover that Sam has several old life insurance policies which would provide $300,000 to Sally if Sam died and the total cash value of the policies are $280,000. The cash value is what the insurance company would pay Sam today if Sam turned in (surrendered) the insurance policies while Sam is alive. After Sam dies, his wife receives only half of his pension and then Sally will have less income than she needs without selling the house. Sally has spent thousands of hours in her flower beds and decorating her kitchen to make her home a very pleasing and comfortable place and has many wonderful memories of family gatherings there. As lawyers, we can do the wills, trusts, powers of attorney and property transfers to make their estate plan perform as they desire. But, the documents do not save Sally’s house.

What is the Central Problem? The central problem in Sam and Sally’s estate is not the legal documents, although the proper legal documents will make sure that their property goes to whom they want, when they want and how they want with the minimum of taxes and expenses. Instead, the central problem is that Sally, who statistically is likely to survive Sam, will not have enough income to stay in her beloved home after Sam dies. The children of Sam and Sally have their own families, are well established and do not need Sam and Sally’s money to live on. Sally does not have the stamina or skills to go back to work.

Providing for the Surviving Spouse. The solution to this central problem is for Sam to exchange his insurance policies for a new insurance policy that will provide enough money for Sally to live on after Sam dies. The tax code under Section 1035 allows Sam to exchange his old policies for a new policy with a higher death benefit and lower cash value without paying any taxes at the time of the exchange even though he is using his untaxed earnings in his insurance policy to buy something of greater value to him. When not being used as an investment and tax saving vehicle, the purpose of life insurance is usually to replace the income of the breadwinner when the breadwinner dies and to shift the risk of a premature death of the breadwinner from the policy holder to the insurance company. Here, with $280,000 of cash value and a death benefit of $300,000, Sam has nearly all of the risk of his death on his shoulders and his insurance is providing him virtually no leverage. We brought this up to Sam and Sally during a review of their estate plan because we ask questions about how much will Sally have to live on after Sam dies, how much insurance they have and what is the cash value of their insurance.

Solving the Central Problem. We referred Sam and Sally to a qualified trustworthy insurance professional. The insurance professional shopped the insurance companies and came up with a policy that will provide a death benefit of $1,000,000 up to age 97 for Sam in exchange for the cash value in the policies. Sam and Sally pay for this by using the cash value in the insurance policies, do not write a new check, do not pay taxes when they trade the cash value for a new policy and have no future insurance payments because they used the cash value to pay for this new policy. If Sam dies before age 97, Sally receives $1,000,000 and this, with their other assets, will be enough for Sally to stay in her beloved home. Of course, Sam had the alternative of taking the $280,000 out of the policy and investing it in hopes that next year or any year thereafter he would have grown the $280,000 to $1,000,000. With many experts stating that the stock market will be flat for the next 6-9 years, how will Sam invest these funds to make sure the $1,000,000 would be there for Sally? The insurance company invests these funds, takes over the risk that Sam will die soon, and guarantees to pay the $1,000,000 under the terms of the contact and makes a profit.

How Can This Happen? I do no know why Sam’s prior insurance agent never talked to Sam about this problem. If Sam had consulted any of the financial planners we work with, the financial planner would have brought up this solution. This happens too often because in this era of specialization, the specialist attorney or other advisors put their blinders on and only look at what concerns their narrow specialty rather than solving the problems of their clients. We spotted the problem and bought in an insurance professional with the license, credentials, honesty and experience to solve the problem. What is a necessity for an estate plan that meets all of your goals is that you must have a team of professionals looking out for you – your accountant, your lawyer, your insruance professional, your financial planner and your personal banker. All of them have a contribution to maqke to protect you and your family.

Plan Now. If you want a comprehensive estate plan, call us for an appointment for a review by our team.