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ESTATE WISE PLANNING TM
Since 1979
By: Doug H. Moy
Consulting Specialist in Estate and Gift Taxation and Planning
Member, National Association of Tax Professionals (NATP)
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Published by: Doug H. Moy, Inc., P.O. Box 254, Lake Oswego, OR 97034
(503) 636-5855
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Vol. I, No. 8. August 2005
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Deferred Installment Payment of Estate Tax: If the gross estate includes the decedent’s interest in a closely-held business, the estate tax attributable to the value of the decedent’s interest in the business may be paid in installments (interest at 2 percent on the first $1,170,000 for five years, payment of principal and interest at the going rate years six through fifteen). For an estate of a decedent dying in calendar year 2005, the dollar amount used to determine the "2-percent portion" [for purposes of calculating interest under IRC Section 6601(j)] of the estate tax extended as provided in IRC Section 6166 is $1,170,000 [Rev. Proc. 2004-71, 2004-50, I.R.B. 970 at .34].
The decedent must have been a U.S. citizen or resident of the U.S. at the time of death [IRC Sec. 6166(a)(1)]. The value of an interest in a closely-held business which is included in the gross estate must exceed 35 percent of the decedent’s adjusted gross estate (AGE) [IRC Sec. 6166(a)(1) and (b)(6)]. The value of any interest in a closely-held business does not include the value of that part of the interest which is attributable to passive assets held by the business. Generally, a passive asset is any asset not used in carrying-on an active trade or business [IRC Sec. 6166(b)(9)].
Perhaps the most controversial issue regarding passive assets is that of rental or income-producing real estate. The level of the decedent’s activity is the factor that distinguishes an active business from mere passive ownership of income-producing assets [with regard to oil and gas royalties being an active asset in the decedent’s gross estate, see Doug H. Moy, "Deferring the Payment of Federal Estate Tax Under Sec. 6166 in View of TAM 9214010," 18 Tax Management Estates, Gifts and Trusts Journal 107 (July-August 1993). The author defended against TAM 9214010 on behalf of the decedent’s estate in a Conference of Right in the National Office of the IRS in Washington, D.C., Sept. 12, 1991]. In determining the level of business activity carried-on by a proprietorship, partnership and/or corporation, the activities of its agents and/or employees are taken into account. The activities of persons, such as independent contractors or lessees who are neither agents nor employees, on the other hand, are not taken into account (Doug H. Moy, A Practitioner’s Guide to Estate Planning: Guidance and Planning Strategies, 2 vols., Aspen Publishers, Inc., 2003, Sec. 2.01[J][4] at 2-48).
The following rulings by the IRS provide additional guidance re the meaning of an active business interest in contrast to passive ownership: Revenue Rulings 75-365, 1975-2 C.B. 471; 75-367, 1975-2 C.B. 472; 75-366, 1975-2 C.B. 472; and Letter Ruling 9801009. Also, in Letter Ruling 9250022 the decedent’s interest in a corporation that owned rent-controlled and rent-stabilized apartment buildings was an active business for purposes of IRC Section 6166, and cash reserves held by the decedent’s corporations and a partnership are interests that constitute a "closely held business amount" for purposes of IRC Section 6166(b)(5). In Letter Ruling 9832009, the level of the decedent’s activity in various phases of commercial real estate development and a leasing business constituted an interest in a closely-held business for purposes of IRC Section 6166.
Finally, in Letter Ruling 200518047, where the decedent’s activities included the hiring and firing of all key employees; setting compensation; attending monthly meetings to inspect the properties; meeting with staff, customers, contractors; and making purchasing, maintenance and capital improvement decisions; personally reviewing daily operations reports for two to three hours per day; and consulting on all nonroutine decisions, decedent’s activity constituted an active business—not a passive investment interest—in his closely-held business operations.
Pre-1977 Joint Tenancy and IRC Section 1031: Recently, during my presentation to members of the Certified Commercial Investment Member (CCIM) meeting, a member inquired of me if the pre-1977 treatment of property owned jointly with right of survivorship by married spouses remains with respect to the property received in an IRC Section 1031 exchange. IRC Section 1031 provides that no gain or loss will be recognized when property held for the productive use in a trade or business or for investment is exchanged solely for property of like kind. If the exchange is for like-kind property, as well as other property or money, no loss will be recognized and gain will be recognized only to the extent of such money and the fair market value of the other property received. While the question may seem esoteric, nevertheless, it is a practical question, since at least two estate planning issues are involved as a consequence of the answer to it: (1) if the property received in exchange for the pre-1977 property is titled in the name of the husband and wife as joint tenants with right of survivorship, would the joint tenancy with right of survivorship ownership in the exchange property be deemed "created" before 1977? and (2) if the property received in exchange is subsequently transferred to a revocable living trust, the pre-1977 rule may no longer be applicable with respect to the acquisition date of the initial property given in exchange for the new property, since the "survivorship" element of the joint tenancy would be severed.
The answer to these issues on point is nowhere to be found in the Code, Regulations or case law. In this regard, it is elementary that the province of construction lies in the domain of ambiguity [Helvering v. Northwestern Nat. Bank & Trust Co., 89 F.2d 553, 556 (8th Cir., n.d.); United States v. Missouri Pacific R. Co., 278 U.S. 269, 277, 49 S.Ct. 133, 73 L.Ed. 322] and that the use by a legislative body of words having definite meanings creates no ambiguity and that such words are to be taken and understood in their plain, ordinary and popular sense [Bates Mfg. Co. v. United States, 303 U.S. 567, 572, 58 S.Ct. 694, 82 L.Ed. 1020; Old Colony R.Co. v. Comm’r, 284 U.S. 552, 560, 52 S.Ct. 211, 76 L.Ed. 484; Montgomery Ward & Co. v. Snuggins, 103 F.2d 458, 461 (8th Cir., n.d.); Von Weise v. Comm’r, 69 F.2d 439, 411 (8th Cir., n.d.)]. In this regard, it is safe to say that a sale is a transfer of property for a price in money or its equivalent and that an exchange is a transfer of property for other property of value [See and Compare: 55 C.J. 66, Sales Subsection 30-35; 23 C.J. 188, Exchange of Property, Subsection 5, 25; Norfolk & W.R. Co. v. Sims, 191 U.S. 441, 447, 24 S.ct. 151, 48 L.Ed. 254; United States v. Hendler, 303 U.S. 564, 566, 58 S.Ct. 655, 82 L.Ed. 1018; Fairbanks v. United States, 306 U.S. 436, 59 S.Ct. 607, 83 L.Ed. 855, aff’g, 95 F.2d 794 (9th Cir., n.d.); Wieboldt v. Comm’r, 113 F.2d 384 (7th Cir. n.d.); Bingham v. Comm’r, 105 F.2d 971 (2d Cir., n.d.); Rogers v. Comm’r, 103 F.2d 790 (9th Cir., n.d.); Felin v. Kyle, 102 F.2d 349 (3rd Cir., n.d.); Hale v. Helvering, 66 App.D.C. 242, 85 F.2d 819; Cary v. United States, D.C., 22 F.2d 298; Chicago, G.W.R. Co. v. Postal Tel. Cable Co., 249 F. 664 (7th Cir., n.d.); Baltimore & O.R. Co. v. Western Union Tel. Co., D.C., 241 F. 162; Crocker-Wheeler Co. v. Bullock, C.C., 134 F. 241, 248; Henderson v. United States, D.C., 22 F.Supp. 206; Polin v. Comm’r, 39 B.T.A. 951; C. L. Gransden & Co. v. Comm’r, 39 B.T.A. 985]. Thus, it may be reasonably assumed that, if the form of legal title is not altered, that is, for example, the joint tenancy with right of survivorship (or tenancy by the entirety with right of survivorship) is not destroyed with respect to the acquisition of the "exchanged" property, then, the pre-1977 rule should continue to apply to the real property received in the exchange.
Washington State Estate Tax Update: Recently, the Washington State Supreme Court declared the Washington State estate tax "inconsistent" in view of the repeal of the federal state death tax credit effective January 1, 2005 [see Estate Wise Planning, Vol. I, Jan. 2005]. In response to this action, the Washington State Legislature enacted a new stand-alone estate tax on estates of decedents dying on or after May 17, 2005, with a taxable estate of more than $1.5 million in 2005 and $2.0 million in 2006 and beyond. The tax rates are 10 to 19 percent of the taxable estate. Certain deductions are allowed farmers. The Washington State estate tax is expected to generate about $100 million per year, increasing slowly over time. An estate with a gross value of at least $1.5 million in 2005 and $2 million in 2006 and beyond must file a tax return within nine months of death. However, these amounts are deducted from the taxable value of the estate; and tax is due only on amounts exceeding these thresholds. The value of farm land and farm equipment can be deducted from the taxable value of an estate as long as either the land or equipment comprises at least one-half of the total value of the estate and meets other statutory requirements. This deduction is in addition to the applicable $1.5 million or $2 million deduction. Unlike the special use valuation requirements under IRC Section 2032A, the heirs (or beneficiaries) to the farm land and farm equipment are not required to repay the difference in the tax if the heirs (or beneficiaries) do not continue farming—that is, recapture of the estate tax that would have been imposed but for the value of the land and equipment used in farming if the decedent’s heirs (or beneficiaries) had not continued farming.
Transfer of LLC Interests to Revocable Living Trust: Often, real estate brokers create real property investment opportunities structured as limited liability companies (LLC). In such cases, the trustee of a revocable living trust should be empowered (but not directed by the trustor) to be subject to the LLC Operating Agreement, thereby, causing the trustee to be bound by the terms and conditions of the Operating Agreement and to be given the discretion to continue such business for such period as the trustee determines. Such power provides continuity of management by the trustee of the LLC with respect to the trustor’s interest in the LLC. For assistance in this regard when working with your attorney, please let him or her know of my knowledge in this specialized area.
Environmental Liability Real Estate: Generally, when the subject of environmental hazards enters into a discussion, one assumes that oil and gas pollution is the focus of conversation. While oil and gas may constitute a environmental hazard, a more serious growing threat to the environment is the manufacture of methamphetamine [42 USC Sec. 9602(a)]. This is particularly troublesome if the real property is income producing and the owner is unaware of the tenant’s drug manufacturing activity and either has or is in the process of conveying legal title to the property to the trustee of his or her revocable living trust. Under federal environmental laws, the trustee (defendant) of a revocable living trust may be liable for toxic clean-up costs associated with property transferred to the trust [42 USC Sec. 9601(35)(A)]. A defendant is not liable for such costs if the property is acquired under the terms of the decedent’s Last Will [42 USC Sec. 9601(35)(A)(iii)]. However, with respect to a revocable living trust, the trustee is not liable for the clean-up costs if, at the time the defendant (trustee) acquired the facility, the trustee did not know and had no reason to know that any hazardous substance was disposed of on, in or at the property [42 USC Sec. 9601(35)(A)(i)]. To establish that the trustee (defendant) had no reason to know that a hazardous substance existed on the property, the trustee must have undertaken, at the time of acquiring the property, all appropriate inquiry into the previous ownership and uses of the property consistent with good commercial or customary practice in an effort to minimize liability [42 USC Sec. 9601(35)(B)]. If the trustor owns property that he or she suspects or knows is contaminated, legal title to the property should not be conveyed to the trustee of a revocable living trust. Instead, such property should be made part of the trustor’s probate estate so that it will pass to his or her beneficiary(ies) under the terms of the decedent’s Last Will. By doing so, neither the decedent’s personal representative nor the beneficiary may be liable for the cost of toxic clean-up [See 42 USC Sec. 9601(35)(A)(iii)].
Question of the Month: May my spouse and I name different trustees under our revocable living trust? Answer: Yes. Though not common, a husband and wife may be the trustees of their respective property interests under a joint revocable living trust but, for a variety of reasons, may not want to designate one another as successor trustees. Such may be the case in second-marriage (or more) situations where each spouse wants to designate his or her children or a separate corporate entity as successor trustee as to that spouse’s property interests in the revocable living trust. In families where the children by each spouse’s former marriage have good relationships and are in accord as to their respective parents’ estate planning objectives, such a trustee arrangement can operate effectively. The same trustee arrangement can also be effective if each spouse has his or her own separate revocable living trust.
AFR: The August Applicable Federal Rate, under IRC Section 7520, for determining the present value of an annuity, an interest for life or a term of years or a remainder or reversionary interest is 4.8 percent (Rev. Rul. 2005-54, 2005-33 IRB 1). This bodes well for the grantor retained annuity trust (GRAT), charitable lead annuity trust (CLAT), charitable transfer of remainder interest in residence or farm and private annuities but not well for the qualified personal residence trust (QPRT), grantor retained income trust (GRIT) and charitable remainder annuity trust (CRAT). Lower AFRs have no impact on grantor retained unitrust (GRUT), charitable remainder unitrust (CRUT), charitable lead trust (CLT) and pooled income funds.
Copyright 2005 by Doug H. Moy. All rights reserved. Without limiting the rights under copyright reserved above, no part of this publication may be reproduced, stored in or introduced into a retrieval system or transmitted, in any form or by any means (electronic, mechanical, photocopying, recording or otherwise), without the prior written permission of the author and copyright holder of this material. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is made available with the understanding that neither the author nor Doug H. Moy, Inc. and/or employees is/are engaged in rendering legal or accounting services. If legal advice or accounting assistance is required, the services of a competent professional should be sought.
Contact Doug H. Moy at dougmoy@msn.com or at (503) 636-5855 in regard to:
Referrals — always welcome
Initial consultation appointment
Updating or reviewing an estate plan
Preparing Estate Tax Return Form 706
Client questions and concerns
Speaking/teaching opportunity
Doug H. Moy, President
Doug H. Moy, Inc.
PO Box 254
Lake Oswego, OR 97034-0030
Telephone: (503) 636-5855
Fax: (503) 697-7749
dougmoy@msn.com
Available at most book stores for $39.95: Moy, Doug H., Living Trusts, Third Edition. John Wiley & Sons, Inc., 2003. Or visit http://www.wiley.com/WileyCDA and enter "Doug Moy" in Product Search "by Author."
"This is an extremely accessible work,
written in a clear, conversational tone....
This is a very commendable work,
equally appropriate in the professional’s
office library or at home on the den bookshelf....
Highly recommended."
Nancy Shurtz, "Estate Planning,"
July 2004, Vol. 31/No.7, p. 357.
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