Estate Tax 2010

Many older taxpayers work to move wealth they've generated in their lifetimes from one generation to another while minimizing tax liability through estate planning. Intergenerational transfers of wealth have a significant impact on the economy and many believe that the estate tax generates costs to taxpayers, the economy and the environment that far exceed any potential benefits that it might arguably produce. Still, the political landscape today seems to indicate estate taxes are here to stay.

When dealing with estate planning, many older generation taxpayers deed property into a family partnership or LLC. Children receive an ownership percentage "gift" each year that transfers ownership over time. The parents that have acquired the real estate are able to continue to take income from the property but their heirs receive the property without estate tax (up to $1 million in lifetime gift tax exemption). If property is sold, the LLC can utilize a 1031 exchange to sell the investment property and allow the real estate portfolio to grow tax deferred. When the parents pass on, the children then have an ownership in the investment property outside the estate.

If there is not time to do this advance planning, the heirs are subject to an estate tax. This tax had been getting less concerning for many taxpayers due to the Bush tax cuts in 2001 that increased the exemption amount and reduced the tax rate. The tax was set to expire in 2010. It was expected that Congress would re-visit the estate tax before the end of 2009 and put some structure in place. They did not. Because of a limited time circumstance confusion reigns in the current estate tax landscape.

Both the estate tax and the generation-skipping transfer tax (on assets given to grandchildren) were repealed at the end of 2009. If Congress and the President do nothing, both taxes are scheduled to return in 2011 at the unfavorable rates that applied in 2001. The amount that is exempt from each of these taxes will then be $1 million and the tax on the rest will be 55%. Most tax writers do not want this to happen and talks on the estate tax are already underway.

Congress is talking about reinstating the estate tax retroactively to January 1st, 2010 and reviving the "date of death" value for inherited assets. Given the size of some estates, like the one of billionaire Dan Duncan, some are likely to challenge the retroactive imposition of the estate tax and there is a long shot that a proposal gaining ground may give estate a choice in 2010. However, there are past court cases that suggest restoring the tax this way is perfectly legal and could be upheld. Of course, the sooner Congress acts, the fewer number of large estates likely to bring such cases and the less chance these heirs will have to call the tax unconstitutional.

Members of the House of Representatives generally support a proposed $3.5 million exemption and a 45% rate on estates. There is growing support in the Senate for a $5.0 million exemption and a 35% top tax rate. We'll see, in the coming weeks and months, how this plays out and we'll certainly do our best to keep you posted of any news.

By conferring with your tax professional, and utilizing the tools of estate planning and 1031 exchanges together, one can minimize the effects of capital gains taxes on investment property. If you have are considering selling your investment property and want to defer capital gains tax using the tools of a 1031 exchange, please contact the professionals at 1031 Corporation. We have years of experience and work with accounting professionals to structure an exchange to minimize the tax impact on your investment assets. Give us a call today at 888-367-1031.

Family Limited Partnerships

In managing federal estate taxes, the use of Family Limited Partnerships (FLPs) has proven to be a beneficial planning technique. During the last two decades, FLPs gained popularity. They also attracted the attention of the Internal Revenue Service (IRS).

Due to the FLPs extraordinary tax benefits, the IRS has audited many FLPs. But this IRS challenge should not be viewed as their demise. Rather, IRS audits reveal proper FLP use and maintenance.

Benefits of the FLP
An FLP is a powerful estate planning tool that can help reduce future taxes. This tool may be very handy as estate taxes may soon be at an all time historic high. For those who pass away after 2010, the tax law would impose a steep estate tax or "death tax" burden of up to 55% of ranch value!

Using an FLP can help ease this tax burden. Through an FLP, a senior family member can reduce the estate tax and keep control of the family operation.

An FLP is often formed by a member of the senior generation who transfers family assets to the partnership in exchange for both general and limited partnership interests. Some or all of the limited partnership interests are then gifted to the junior generation. The general partner need not own a majority of the partnership interests. In fact, the general partner can own only 1 or 2% of the partnership, with the remaining interests owned by the limited partners.

This structure produces several advantages:

The senior family member can gift limited partnership interests to junior family members at less than the full fair market value of the underlying assets.

The use of the partnership entity allows a senior family member to shift some of the form and ranch income and future appreciation to other members of the family.

The senior family member retains management and control while transferring away limited ownership interests.

The senior family member can also place restrictions within the partnership agreement that ensure continuous family ownership.

At death, the senior family member's estate tax bill may be reduced since only the value of the decedent's partnership interest will be taxed.

IRS Scrutiny: Potential Concerns with the FLP
The IRS has taken a more aggressive stance regarding FLPs. Over the past several years, the IRS has had success in attacking FLPs with the most common problems being:

Failure to Follow Formalities. FLPs are required to have Partnership Agreements that must be followed. Although FLPs have far fewer formalities than corporations, the partners should have regular meetings, take minutes, and treat the entity with the formality expected of a non-family business.

Inadequate Valuation Reports. The IRS is often critical of both the quality and content of the family's valuation appraisals. To avoid the IRS attention, the family should retain accredited appraisers experienced with the requirements of estate tax appraisals.

Non-business Assets or Activities. FLPs are business entities and are not meant for personal use. The family homestead should not be placed into an FLP, nor should normal family expenses (utilities, clothing, educational expenses, etc.) be paid from the FLP.

Other "red flags" include commingling FLP and personal income, preparing FLP financial records after death and forming "deathbed" FLPs.

FLPs need annual care and regular maintenance. With this care, FLPs can achieve substantial federal estate and gift tax savings. For farm and ranch families with large illiquid estates, FLPs can be a very beneficial tax savings tool.

Denise Hoffman is a senior associate with the law firm Rothgerber Johnson and Lyons LLP. If you or your family has questions concerning Family Limited Partnerships, please call Denise at 303-628-9523 or contact her by e-mail at dhoffman@rothgerber.com.

Senate Estate Tax Alternative Hearings Expected to Yield No Action

Last week, the Senate Finance Committee met to discuss "Alternatives to the Current Federal Estate Tax System". This was the second of three hearings scheduled. Issues surrounding the possible administrative burdens to the Internal Revenue Service and the role of government in estate taxation. Also discussed were the complaince with budgetary rules and precautions to a new estate taxation system. Members reviewed the accessions tax and comprehensive inheritance tax.

Despite adding amendments to the Senate budget resolution and these three scheduled hearings, experts believe that it is unlikely there will be any substantive movement on the estate tax issue this year. More likely, the issue could be addressed next year before the 2010 one year full repeal and reversion to pre-2001 law that would occur in 2011.