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Estate Taxes

Family Business Changes of Ownership & Estate Planning

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By: Jeffrey D. Urbach, CVA, CPA/ABV/CFF

Business owners have been saving estate taxes by transferring assets in the form of FLPs (Family Limited Partnerships)

Family Business

or outright gifts of company stock to family members.
The tax savings are the result of discounts taken by business appraisers on the value of the gift.

The IRS is proposing to disallow these discounts as of Jan. 1, 2017.
Based on many published surveys, selling a non-controlling interest can result in a 30 to 40% (or more) total discount off the value of the company because of the combination of the following two discounts.
These discounts are commonly called Minority (or Control) Discounts and DLOM (Discounts for Lack of Marketability).
A simple example:
Company A is worth $10,000,000 and 100% of the shares are owned by Mr. Smith. Assume he wants to gift 1/3 of the company to his daughter. The appraiser valued the company at $10,000,000 and in her judgment, the gift would warrant a combined Marketability and Control discount of 40%.
On the face of it, a 1/3 interest of a $10,000,000 is $3.3 Million. After application of the 40% discount ($1.32 Million), the value of the gift becomes $1.98 Million. ($3.3 million less $1.32 Million, or $1.98 million).
In the end, Mr. Smith removes $3.3 of value from his taxable estate and pays a Gift Tax on $1.98 million, say roughly 40% or $790,000. The same 1/3 interest, if left in his estate would have incurred a tax of $1.3 Million ($3.3 Million times 40%).
The gift saved his family $510,000 ($1.3 Million less $790,000).
The new IRS proposals to disallow these discounts may take effect on January 1, 2017. You should consult with your estate attorney and other financial advisors ASAP and to have a strategy in place when and if this change occurs.

Avoiding a Marriage Commitment? Pay NJ Estate Taxes Instead

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People say that love conquers all, but a decision by the New Jersey Tax Court indicates that doesn’t always hold true.

The issue

In a ruling that’s sure to upset some cohabitating couples, the court earlier this year ruled that, for state tax purposes, the estate of a wealthy Alpine woman could not take a marital deduction for a multimillion-dollar payout to her longtime live-in companion—even though the deduction was permitted for federal purposes. The case presents a clear example of how state tax law does not always follow federal tax law, even though NJ tax positions are, for the most part, based on Federal ones.

Here’s the detail on the background

The decedent Lillian Garis Booth died testate on November 22, 2007 at age 92, leaving an estate worth some $200 million. Although fellow New Jersey resident Misha (Michael) Dabich and Booth cohabited together for approximately 51 years, he was not named as a beneficiary in her will. About two years later, however, the Estate reached a $9.9 million settlement with Dabich.

Trouble began brewing, however, when the Estate filed an amended NJ IT–Estate and a second amended IT–R in March 2010, seeking, among other changes, a net refund of previously paid taxes totaling $1.5 million. The amended items reflected, among other things, a deduction for the $9.9 million paid to Dabich, under the theory that their lengthy cohabitation period constituted a “common-law” marriage.

In April 2011, the NJ Dept. of Taxation issued a Notice of Assessment based on the amended IT–Estate. Among other adjustments, the Notice denied the $9.9 million marital deduction. The Court’s reasoning, according to the Notice, was that “[t]he common-law marriage claim of  Dabich is not recognized by” New Jersey, thus, the estate’s claim for marital deduction was being “disallowed for NJ estate tax and inheritance tax” purposes.

The Court added that it was “not bound by the IRS determination to recognize Misha Dabich as a common-law spouse” pursuant to a September 2008 settlement with Dabich and a subsequent 2009 amendment.

In July 2011, the Estate filed a timely administrative protest, maintaining that NJ Dept. of Taxation could not use the Inheritance Tax laws to disallow estate expenses, since the NJ estate tax is the federal “State death tax credit amount;” therefore, expenses allowed by the IRS must be allowed by NJ.

But after another denial, the Estate filed a lawsuit challenging, among other issues, the disallowance of the marital deduction.

In its response, the Tax Court noted that “The burden is upon the executor of an estate to prove facts establishing that “[t]he decedent was survived by a spouse” and “[t]he property interest passed from the decedent to the spouse.” For federal purposes, it reported, the IRS recognized “common-law” marriages “for over 50 years, despite the refusal of some states to give full faith and credit to common-law marriages established in other states” since “uniform nationwide rules are essential for efficient and fair tax administration.”

The reasoning

But, pursuant to state amendments made in 2002, the New Jersey estate tax was decoupled from the federal estate tax, and “was imposed independently of the federal estate tax and of the federal credit for state death taxes.”

Additionally, according to the Tax Court, the NJ Legislature specifically rejected the concept of common-law marriage, and “Although it is the federal estate tax law which provides for a marital deduction, it is State law that determines whether an individual is a spouse for purposes of application and allowance of that marital deduction.”

The decision could reportedly cost the estate some $1.5 million in net NJ Estate & Inheritance Taxes.

Should you be concerned?

The ruling appears to break new ground. Although it only addresses an allowable estate deduction, it also illustrates the way that common misperceptions can result in a costly tax bill. That’s one more reason to speak with your tax, accounting or legal advisor before committing yourself to any kind of significant activity.

 

Provide for Your Loved Ones with Prudent Estate Planning

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The recent, tragic passing of Robin Williams reminds us of just how fleeting life can be. The void in his loved ones’ hearts may never be filled, but the popular entertainer did take steps to care for them financially by engaging in effective estate planning. Among other acts, Williams reportedly created a revocable trust before he died. 

Revocable Trusts

Sometimes known as “living trusts,” a revocable trust refers to a fiduciary arrangement that you (the grantor) create during your lifetime. A living trust can help a grantor manage his or her assets, and protect the individual if he becomes ill, disabled or challenged as he ages.  

During your lifetime, you (the grantor) may transfer property to the “living trust,” which will be administered by a trustee you have selected; and during that time he or she is generally responsible for managing the property as you direct, for your benefit.  

Once you pass away, the trustee is generally obligated to distribute the trust property to your beneficiaries, or to continue to hold it and manage it for the benefit of the beneficiaries.  

How Do Wills and Trusts Differ?

Although both a will and a revocable trust can provide for the distribution of property upon your demise, a revocable trust can also provide you with a way to manage your property during your lifetime. A revocable,

or “living” trust may also enable the trustee to manage the property and use it for your benefit, and your family’s benefit, if you become incapacitated. Of course, the trust must be adequately funded when you are mentally competent to be useful. If the revocable trust is properly funded and structured, it can help avoid the need for a court-appointed guardian, if you become mentally incapacitated.

Most revocable trusts will not help a grantor avoid estate tax, but they may help you avoid probate, which is generally not expensive in New Jersey but may still expose the will to public scrutiny.

Talk To Your Trusted Advisor First

In some circumstances, particularly when a special needs individual is involved, it may be advisable to establish a kind of irrevocable trust called a “Special Needs Trust.” An SNT may enable the grantor to ensure that his or her assets will enhance the lifestyle of the special needs person without impairing his or her ability to receive government benefits. 

There are many issues to consider regarding the establishment of a trust, so before making a decision about setting up either a living trust, a will or another approach, it may be advisable to consult with your account and/or attorney, who can help you to consider the tax and other implications and the costs and benefits.  

Executors Beware: NJ Law Requires Child Support Search Prior to Distribution

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If you are executor of an estate in New Jersey and intend to make a distribution to the beneficiaries, there’s one important step you need to take first. NJ law requires an executor/administrator to initiate a child support enforcement order for any beneficiary receiving in excess of $2,000 prior to the distribution. The executor is personally liable for making a distribution without initiating the order, as the Child Support Judgment is a lien against the net proceeds of any inheritance in NJ.

The search must be conducted by a private judgment search company that will verify results. Urbach & Avraham’s estate administration services include the performance of Child Support Searches. If you would like assistance with your Child Support Search, call us at 732-777-1158 or email Pamela at pma@ua-cpas.com

 

 

 

Take Advantage of our Updated Executor Checklist

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Urbach & Avraham, CPAs, is proud to offer an executor checklist to help alleviate the nightmare of financial affairs of a deceased relative. This comprehensive list, which is regularly updated to reflect the latest changes in estate tax regulation, will help you:

  • Ensure compliance with tax requirements
  • Take advantage of tax saving opportunities
  • Preserve the assets of the estate
  • Clarify the tax ramifications of distributions
  • To view the checklist, click here: Executor To-Do List

Life Insurance Proceeds: Name your Heirs or the Government Shares!

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Do you have a life insurance policy without a specified beneficiary (other than your estate)?  Are you leaving your estate (residuary estate) to individuals other than a spouse or child?

Many people assume life insurance proceeds, regardless of who the beneficiary is, are exempt from NJ Inheritance tax.  Therefore, even if they are leaving their estate to a beneficiary who is not a spouse or child, they see no need to designate a beneficiary for the life insurance policy.  However, life insurance left to an estate where the ultimate beneficiary is not a spouse or child is not exempt from NJ Inheritance tax.  As NJ Inheritance taxes can be as high as 16%,  it is prudent to take the simple step of naming a beneficiary to avoid the NJ Inheritance Tax. 

Unfortunately life insurance policies owned by individuals are includable for NJ Estate tax purposes, regardless of who is named as the beneficiary, if the assets of the estate are at least $675,000 (not an uncommon scenario for an insured decedent).  However, unless you cherish Chris Christie more than your loved ones, you can at least avoid paying NJ Inheritance taxes by simply naming an individual as beneficiary on your life insurance policy.     

Let’s illustrate:                                                              

Example #1: Uncle Harry dies and names his nephew in his will as sole heir of his entire estate. His only asset is a $500,000 life insurance policy. Since his estate is less than $675,000 there is no US or NJ Estate tax. If he named his nephew as beneficiary of his life insurance policy, there is no NJ Inheritance tax as well. However, if there is no named beneficiary (the estate is the beneficiary), the $500,000 is subject to a 15% inheritance tax, or $75,000.

Example #2: Same as above, except the policy is $1,000,000. NJ law states that the estate calculates the estate tax and the inheritance tax and pays the greater of the two, not both. The NJ Estate tax on $1,000,000 is $33,000. If Uncle Harry named his nephew as beneficiary, the inheritance tax is zero and the estate pays $33,200. If Uncle Harry did not name his nephew as beneficiary, the inheritance tax is 15-16% of $1,000,000 or $153,000. The Estate pays $153,000. The cost of not naming a beneficiary is $119,800 ($153,000 less $33,200).