The Gift of Education Re: Estate Planning

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Many grandparents want to enrich the lives of their grandkids, but are not sure the best way to accomplish this with their estate plan. I encourage clients to consider helping their grandchildren with the future costs of education. The proper planning can help grandkids avoid hefty loans and be tax-efficient for the donor.

A grandparent may currently gift up to $14,000 per grandchild (or to anyone) per year tax free ($28,000 if a married couple gift-splits). Any gift over that amount requires the filing of a gift tax return.

However, if you pay for a grandchild’s education expenses directly to the provider (i.e., educational institution), the gift is excluded from your annual exclusion amount. For purposes of this exclusion, the term “educational institution” covers a broad range of schooling, such as primary, preparatory, vocational or university institutions. This kind of payment is also exempt from the generation-skipping tax (which is too complicated to explain herein, but can significantly reduce a grandparent’s gifting amount). In short, if you pay $40,000 to cover your grandchild’s tuition directly to the school, you can still gift up to $14,000 tax free to him or her in the same year. Some institutions may even allow a donor to pay upfront the applicable years of education at a locked-in tuition rate, so as to avoid rate hikes.

Another option to consider is a 529 college-savings plan. One of the biggest benefits of this plan is that it can continue operation when the grandparent is no longer around to write checks to an institution. A grandparent can gift up to the annual exclusion per year tax free, or make up to five years’ worth of the annual exclusion gift ($70,000 per single donor or $140,000 per couple) in one year to benefit a single individual. However, this has its drawbacks. If you gift the five year maximum amount in one year, any other annual exclusion gifts to that beneficiary for the next five years will incur gift tax consequences. Further, if you die within five years of the date of the gift, a prorated portion of the gift will be included in the estate tax calculation.

Article by:

Terri R. Stallard

Of:

McBrayer, McGinnis, Leslie and Kirkland, PLLC

The IRS/Treasury Department Announcement & Estate Planning Ruling Re: Same-Sex Marriage

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On August 29, 2013, the Treasury Department and the Internal Revenue Service (“IRS“) issued Revenue Ruling 2013-17. The ruling establishes that the IRS will recognize same-sex marriages for all federal tax purposes regardless of where the couple lives, as long as the couple was married in a jurisdiction that recognizes such marriages. So, for example, if a couple was married in Connecticut (a recognizing state), but now live in Kentucky (a non-recognizing state), they will receive the same federal tax treatment as heterosexual couples residing in Kentucky. The ruling clarifies that a “state of celebration” approach will be used versus a “state of residence” rule. Treasury Secretary Jacob J. Lew says the decision “[a]ssures legally married same-sex couples that they can move freely throughout the country knowing that their federal filing status will not change.” It is important to note that, according to the ruling, “marriage” does not include a registered domestic partnership, civil union or other similar arrangement. The ruling applies to all federal tax provisions where marriage is a factor, including: filing status, estate tax exemptions, personal and dependency exemptions, the standard marriage deduction, IRA contributions, earned income tax credits and employee benefits.

The ruling came on the heels of the Supreme Court’s June 2013 decision in United States v. Windsor and is meant to address some of the confusion that Windsor left in its wake. As background, before Congress enacted the Defense of Marriage Act (“DOMA“), marital status for federal income tax purposes was defined by state law. Section 3 of DOMA banned same-sex couples from being recognized as “spouses” for all federal law purposes. Windsor ruled Section 3 of DOMA unconstitutional; however, the decision did not require states to recognize same-sex marriages. Thus, since June, state and federal agencies have been wondering how to deal with same-sex marriages in non-recognizing states. With the Revenue Ruling, much-needed guidance has arrived.

From the estate planning perspective, there are now several more options that same-sex couples can use to their advantage. First, same-sex spouses are now eligible for the marital deduction, which means that they may transfer as much as they want to their spouse (in life and in death) without incurring federal estate or gift tax, provided that the recipient spouse is a U.S. citizen.

Another benefit is the use of “gift-splitting.” Any individual can give up to $14,000 each year to as many people as they choose without incurring gift tax. Heterosexual spouses, and now same-sex spouses, can combine their $14,000 to jointly give $28,000 to individuals tax-free.

Same-sex spouses will also now get to take advantage of an estate planning tool known as “portability.” Portability allows a widow or widower to use any unused estate tax exclusions (capped at $5.25 million for 2013) of their spouse who died in addition to their own. The unused exclusion must be transferred to the surviving spouse and an estate tax return must be filed (by the executor) within nine months of the spouse’s death, even if no tax is due.

The ruling also has a myriad of other implications for taxes and employee benefits that should be carefully considered by same-sex couples. There are still lingering questions about how other agencies, such as the Social Security Administration, will address benefits post-Windsor.

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Defense of Marriage Act’s Demise (DOMA) – What it Means for Canadian Residents with U.S. Ties

Altro Levy LogoLast week, the US Supreme Court issued an historic and landmark ruling in the case of US v. Windsor. It has been hailed in the media as the demise of the Defense Of Marriage Act (“DOMA”), and celebrated as an extension of more than 1,000 federal benefits to same-sex couples.

In US v. Windsor, Edith Windsor brought suit against the US government after she was ordered to pay $363,000 in US estate tax upon the death of her wife Thea Spyer. Edith and Thea were legally married in Canada in 2007, but the US federal government did not recognize their marriage when Thea passed away in 2009. Under DOMA gay marriage was not recognized, even if it was legal in the jurisdiction where it was performed. This lack of recognition meant that Edith could not take advantage of the marital deduction that would have allowed her to inherit from her wife without paying US estate tax.

In its ruling on June 26th, the US Supreme Court ruled that the US federal government could not discriminate against same-sex married couples in the administration of its federal laws and benefits as previously dictated by DOMA. Same-sex couples, who are legally married in one of the 13 states that recognize gay marriage, or a country like Canada, now have access to the same federal protections and benefits as a heterosexual married couple.

Tax Benefits

The demise of DOMA will bring with it a multitude of changes under US tax law. We will not attempt to enumerate all of them here, though we will provide a brief overview of key changes for our Canadian and American clients.

i. US Estate Tax

The case of US v. Windsor was based on the US estate tax, which is imposed by the US federal government on both US citizens and residents, as well as non-residents who own US assets worth more than $60,000 USD. Currently US citizens and residents with less than $5.25 Million USD in worldwide assets do not owe US estate tax on death. Canadians with worldwide assets of $5.25 Million USD or less receive a unified credit under the Canada-US Tax Treaty that works to eliminate any US estate tax owed on their US property.

Under federal law a US citizen may pass his entire estate to his US citizen spouse tax-free upon death. Up until last week this rollover was unavailable to same-sex couples.

Canadian same-sex couples should now benefit from the Canada-US Tax Treaty provisions that provide a marital credit to the surviving spouse. This allows for a doubling up of credit against any potential US estate tax due on US property. Now a Canadian same-sex spouse can inherit a worldwide estate worth up to $10.5 Million USD and should see little to no tax on US assets due upon the death of the first spouse.

ii. Gift Tax

The US imposes a tax on gifts if they exceed $14,000 USD per recipient per year. There is an exemption for gifts between spouses, which are generally not taxable.

Gifts made in the US between non-US citizen non-resident spouses are taxable, but the annual exemption is $139,000 USD instead of $14,000 USD. Canadian spouses who gift each other US property, US corporate stocks, etc. may gift up to $139,000 USD per year without incurring US gift tax.

These exemptions have now been extended to same-sex couples, expanding their ability to use gifting for tax and estate planning.

iii. US Income Tax

Many Canadians move to the US each year, in part because of the lower personal tax rates. In the US spouses are allowed to engage in a form of income splitting by filing a joint income tax return. By filing jointly, married couples are also generally able to take advantage of further credits and deductions not afforded to individual or single filers. Being able to file jointly can be highly tax advantageous.

Previously, same-sex couples had to file either separately or as head of household. Now they have the option of filing jointly as spouses, and gaining access to the aforementioned income splitting, credits and deductions.

Couples may file up to three years of amended US Income Tax returns if they believe that they would have been entitled to a larger tax return by filing jointly in those years.

iv. Other Tax Benefits

In the US most individuals receive health insurance through their employer at least up until they qualify for US Medicare at age 65. Previously, if the employer sponsored health insurance plan covered the same-sex spouse as well, then it was considered a taxable benefit. Such coverage will now also be tax-free for same-sex couples.

Retirement Benefits

Among the many benefits now extended to same-sex couples are a variety of “Retirement Benefits.”

i. Social Security and Medicare Benefits

With the end of DOMA, same-sex couples may now qualify for retirement, death, and disability Social Security benefits based on their spouse’s qualifying US employment history. For example, same-sex couples that do not have the required US employment history to qualify for US Social Security benefits on their own may now qualify for spousal Social Security benefits based on their spouse’s qualifying employment history. These spousal Social Security benefits are typically equal to 50% of the Social Security benefits received by the spouse with the qualifying employment history.

Additionally, spouses can qualify for US Medicare based on only one spouse’s qualifying US employment. This allows access to premium-free, or reduced-premium, health coverage in retirement.

Previously these important retirement benefits were not available to same-sex spouses.

ii. Individual Retirement Accounts

Important changes to the rights and recognition of spouses under US retirement savings plans result from the end of DOMA. Same-sex couples will now be recognized under 401(k), 403(b), IRA, Roth IRA, and similar plans. Spouses will be required to give their consent for any non-spouse beneficiary designations for these accounts. They will be treated as spouses for purposes of determining required distributions. For example, an inheriting same-sex spouse will not have to begin IRA distributions until age 70 ½, whereas previously he would have had to begin required distributions immediately as would any non-spouse beneficiary.

Immigration

One of the biggest questions after the US Supreme Court’s ruling on DOMA was whether there would be immediate changes to US immigration policy. Previously the US government did not recognize same-sex couples for immigration purposes. This meant that a US citizen spouse could not sponsor his husband for immigration to the US as a permanent resident (a.k.a. green card holder).

Last week, shortly after the ruling on DOMA, Alejandro Mayorkas, the director of US Citizenship and Immigration Services (“USCIS”) announced at the American Immigration Lawyers Association annual conference that the USCIS would begin issuing green cards to qualifying same-sex couples.

As of Friday, June 29, 2013, USCIS began issuing green cards to same-sex spouses. USCIS has stated that it has been keeping a record of spousal green card petitions denied only due to a same-sex marriage for the past two years. It is expected to reopen and reconsider these spousal sponsorship petitions that were previously denied due to same-sex marriage.

Conclusion

The demise of DOMA is exciting news for Americans, and Canadians with US ties. It provides same sex couples a wealth of new tax and estate planning opportunities, not to mention new opportunities for retirement and immigration planning. It is not too early to review your current planning, and take advantage of these changes.

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Estate Planning Opportunities Arising from Recent Landmark Supreme Court Decisions Concerning Marriages of Same-Sex Couples

Katten Muchin

On June 26, 2013, the US Supreme Court (the “Supreme Court”) struck down Section 3 of the federal Defense of Marriage Act (DOMA) as unconstitutional in the case of United States v. Windsor (“Windsor”). In a related case, the Supreme Court also dismissed an appeal from the federal district court ruling that struck down California’s Proposition 8 (which overturned marriages of same-sex couples in California) as unconstitutional in the case of Hollingsworth v. Perry (“Perry”), leaving intact the district court’s ruling that Proposition 8 is unconstitutional and cannot be enforced. This advisory summarizes the estate and income tax planning opportunities and other topics for consideration arising from the Windsor and Perry decisions. Married same-sex couples should consult with their advisors in light of their particular facts and circumstances in order to take maximum advantage of the change in the law. Unmarried same-sex couples should now consider whether to marry.

In Windsor, Edith Windsor and Thea Spyer, a same-sex couple, were married in Canada in 2007 after having been together in New York for over forty years. New York law did not permit marriages between same-sex couples at the time but recognized marriages of same-sex couples performed in other jurisdictions. Spyer died in 2009, and Windsor inherited all of Spyer’s estate as Spyer’s surviving spouse. However, because of DOMA, which defines “marriage” as “a legal union between one man and one woman as husband and wife” and “spouse” as “a person of the opposite sex who is a husband or a wife”, the federal government refused to recognize the couple’s marriage for federal estate tax purposes. As a result, Windsor’s inheritance from Spyer was not entitled to the unlimited marital deduction from federal estate tax that would have been available had Windsor and Spyer’s marriage been recognized by the federal government. After paying the estate taxes owed on her inheritance as a result of DOMA, Windsor sued for a refund of the estate taxes on the grounds that DOMA unconstitutionally discriminated against same-sex married couples. Windsor prevailed in the US District Court for the Southern District of New York and also in the US Court of Appeals for the Second Circuit. The Supreme Court has now agreed with Windsor, holding that “DOMA seeks to injure the very class [of married same-sex couples] New York seeks to protect. By doing so it violates basic due process and equal protection principles applicable to the Federal Government.” The Supreme Court further explained that DOMA’s “demonstrated purpose is to ensure that if any State decides to recognize same-sex marriages, those unions will be treated as second-class marriages for purposes of federal law.”

In Perry, two same-sex couples wished to become married in California. Though the California Supreme Court held in 2008 that the California Constitution required the State of California to recognize marriages of same-sex couples, California voters passed Proposition 8 later the same year, amending the California Constitution to provide that only “marriage between a man and a woman is valid and recognized in California.” As a result of Proposition 8’s passage, the two couples were unable to marry. They sued the California governor, attorney general and various other state and local officials responsible for enforcing California’s marriage laws (the “California officials”), claiming that Proposition 8 violated their rights to due process and equal protection under the US Constitution. In the US District Court for the Northern District of California (the “district court”), the California officials refused to defend Proposition 8, but the private parties who were the proponents of Proposition 8 (the “Proposition 8 proponents”) successfully intervened to defend the measure. After the district court held that Proposition 8 was unconstitutional, the California officials declined to appeal the decision and the Proposition 8 proponents appealed. The US Court of Appeals for the Ninth Circuit upheld the district court’s ruling that Proposition 8 was unconstitutional. The Supreme Court dismissed the appeal from the district court on the grounds that the Proposition 8 proponents lacked standing to appeal because they were merely private parties and were not properly authorized under state law to defend the constitutionality of Proposition 8. As a result of the Supreme Court’s ruling, the district court’s ruling that Proposition 8 is unconstitutional remains in place and California soon will be required to permit same-sex couples to marry. As a result of the Windsor decision, such marriages also will be entitled to federal recognition.

Estate Planning Opportunities Arising from Windsor 

The Supreme Court’s ruling in Windsor requires the federal government to recognize marriages of same-sex couples. Note, however, that the Supreme Court limited the scope of its decision to “lawful marriages”. Therefore, the decision likely will not be interpreted to require the federal government to recognize so-called “marriage equivalent” status that is not actually “marriage” under state law, i.e., civil unions, domestic partnerships and registered domestic partnerships. The District of Columbia and thirteen states permit marriages of same-sex couples. Those states are California (effective once the stay issued by the Ninth Circuit is lifted pursuant to the Perry decision, which is likely to be imminent), Connecticut, Delaware (effective July 1, 2013), Iowa, Maine, Maryland, Massachusetts, Minnesota (effective August 1, 2013), New Hampshire, New York, Rhode Island (effective August 1, 2013), Vermont and Washington.

Another unresolved issue is whether the Supreme Court’s decision applies to married same-sex couples who lawfully married in a jurisdiction that permits marriages of same-sex couples (e.g., New York), but who are domiciled and/or resident in a state that does not permit or recognize such marriages (e.g., Texas). Accordingly, until these issues are resolved as a result of subsequent litigation, legislation and/or regulation, it is not clear whether Windsor will be interpreted also to apply to same-sex couples with a marriage-equivalent status (but not marriage) or married same-sex couples who are domiciled and/or resident in a state that does not permit and/or recognize marriages of same-sex couples.

Against that background, at a minimum, married same-sex couples domiciled and/or resident in states that permit and/or recognize marriages of same-sex couples likely will be entitled to the more than 1,000 benefits available to married opposite-sex couples under federal law. Some of those 1,000 benefits present immediate estate planning opportunities, including the following:

1. Review estate planning documents to ensure that the amount and structure of any spousal bequests remain appropriate. 

Federal recognition of marriages of same-sex couples leads to the availability of the unlimited marital deduction from federal estate tax and gift tax for transfers between same-sex spouses. Existing estate planning documents may have been drafted with the assumption that any gift or bequest to a spouse of the same sex over and above the individual’s applicable exclusion amount from federal estate tax and/or federal gift tax (the “Applicable Exclusion Amount” —currently $5,250,000, adjusted annually for inflation) would be subject to federal estate tax (currently at a maximum rate of 40%). However, that assumption is no longer true. Indeed, such gifts and bequests, if properly structured, are now entitled to the unlimited marital deduction. In addition, under the so-called “portability” provisions of federal gift and estate tax laws, under certain circumstances a surviving spouse of the same sex will also be entitled to use any portion of the deceased spouse’s unused Applicable Exclusion Amount (the “DSUE”), allowing the surviving spouse to make additional tax-free gifts and/or reduce the amount of estate taxes owed upon the surviving spouse’s death (note, however, that DSUE does not increase the surviving spouse’s applicable exemption from the federal generation-skipping transfer tax (“Federal GST Exemption”)). Accordingly, a married same-sex couple may wish to modify their estate planning documents to provide that any assets included in their estates in excess of the Applicable Exclusion Amounts will pass to the surviving spouse, either outright or in a properly structured marital trust for the spouse’s benefit, thus deferring all federal estate taxes until the death of the surviving spouse.

Estate planning documents may also be revised, if appropriate, to include a separate marital trust that is designed to permit a spouse to use any of the individual’s unused Federal GST Exemption that remains after the individual’s death.

2. Review retirement account beneficiary designations and joint and survivor annuity elections to ensure that they remain appropriate. 

A surviving spouse is entitled to roll over a decedent spouse’s retirement account into the surviving spouse’s retirement account without being required to take minimum distributions or lump sum distributions until such time as the surviving spouse ordinarily would be required to take minimum distributions (usually upon reaching age 70½). As a result of the Windsor decision, this benefit is now available to married same-sex couples. Accordingly, married same-sex spouses should consider naming each other as the beneficiary of his or her retirement accounts in order to defer income tax on the rolled over retirement account as long as possible.

With regard to any retirement plans that are covered by the Employee Retirement Income Security Act of 1974 (ERISA), the spouse of a participant in such a plan may automatically be a beneficiary of the retirement plan as a result of the Windsor decision. Accordingly, if a participant in an ERISA-covered plan (e.g., a 401(k) plan) wishes to designate someone other than his or her spouse as a beneficiary, such participant will need to obtain the consent of his or her spouse to make such a designation effective. Prior to Windsor, consent was not needed from a spouse of the same sex. However, afterWindsor, such consent is now required. Separately, if a participant previously made an election to waive joint and survivor annuity benefits after the date of the marriage, the participant may be able to make a new election at this time, and a new election may be required in order to be valid if the marriage is newly recognized under Windsor.

3. Consider replacing individual life insurance policies with survivor policies. 

Many same-sex spouses previously purchased individual life insurance policies of which the other spouse is the beneficiary (either directly via beneficiary designation or indirectly through a life insurance trust) in order to provide the surviving spouse with sufficient liquid assets that may be used to pay federal estate taxes due upon the death of the first to die. With the unlimited marital deduction and DSUE now available to married same-sex couples, as explained above, there may be little or no need for such liquidity upon the death of the first spouse to die. Thus, a married same-sex couple should consider replacing such individual policies with so-called “survivor” or “second-to-die” policies that pay benefits only upon the death of the surviving spouse. Such policies will still provide liquidity to children or other beneficiaries of the married same-sex couple and are generally less expensive than individual policies having the same death benefits.

4. Consider splitting gifts between spouses. 

Until now, each spouse could make gifts only up to the annual exclusion amount from federal gift tax and/or federal generation-skipping transfer tax (the “Annual Gift Tax Exclusion Amount” and the “Annual GST Exclusion Amount”, respectively—each currently $14,000) without using any portion of his or her Applicable Exclusion Amount. Going forward, however, each spouse may now make gifts from his or her own assets and, with the other spouse’s consent, have such gifts deemed to have been made one-half by the other spouse for purposes of federal gift tax and GST tax laws. Both spouses acting together in this way currently may give up to $28,000 to any individual without using any portion of either spouse’s Applicable Exclusion Amount (note that the Annual GST Exclusion Amount does not always apply to gifts made in trust).

5. Amend previously filed federal estate, gift and income tax returns and/or file protective claims as appropriate.

Gifts made to spouses. If one spouse previously made taxable gifts to the other spouse and reduced the donor’s Applicable Exclusion Amount by the amount that the gift exceeded the Annual Gift Tax Exclusion Amount and/or the donor’s Federal GST Exemption by the amount that the gift exceeded the Annual GST Tax Exclusion Amount, it may be possible to amend the donor’s prior gift tax returns (subject to the limitations period discussed below) and retroactively claim the marital deduction for the gifts made in those years, thus increasing the donor’s Applicable Exclusion Amount and/or reclaim the Federal GST Exemption used. By doing so, the donor may make additional tax-free gifts and/or reduce federal estate and/or GST taxes due upon his or her death. Similarly, any gift taxes or GST taxes actually paid may be refundable.

Gifts made to third parties. To the extent that either spouse previously used a portion of his or her Applicable Exclusion Amount and/or paid gift taxes or GST taxes by making gifts to third parties over and above his or her Annual Gift Tax Exclusion Amount and/or Annual GST Exclusion Amount, it may be possible to amend prior federal gift tax returns in order to retroactively split such gifts with the other spouse, thus increasing the donor’s Applicable Exclusion Amount and/or Federal GST Exemption. Again, doing so will allow the donor to make additional tax-free gifts and/or reduce federal estate taxes and GST taxes due upon the donor’s death. Similarly, any gift or GST taxes actually paid may be refundable.

Inheritances from decedent spouses. In cases where a decedent spouse’s estate paid federal estate taxes on assets that were inherited by a surviving spouse of the same sex, it may be possible to amend the decedent spouse’s federal estate tax return (subject to the limitations period discussed below) and retroactively claim a refund for the estate taxes paid. If the decedent spouse’s estate did not pay estate taxes and he or she died in 2010 or a subsequent year, under the portability provisions of federal estate tax laws, the surviving spouse may be able to claim the deceased spouse’s DSUE, thus allowing the surviving spouse to make additional tax-free gifts and/or reduce the amount of estate taxes owed upon the surviving spouse’s death (note, however, that DSUE does not increase the surviving spouse’s Federal GST Exemption).

Income taxes. Both spouses may also amend prior year income tax returns to change their filing status from single to married filing jointly and obtain a refund if the amount of tax owed based on their married filing status is less than that owed based on their prior single status.

Retroactivity. The extent to which married same-sex couples will be allowed to amend prior tax returns depends on the extent to which Windsor is applied retroactively and whether the applicable limitations period has passed with regard to each tax return (i.e., ordinarily three years from the date the tax return was originally due or filed (if on extension) or two years from the date the tax was paid, whichever is later). For example, it may no longer be possible to amend a 2009 individual income tax return due on April 15, 2010, that was not put on extension, but individual income tax returns for 2010, 2011 and 2012 likely may be amended. That said, it is conceivable that the Internal Revenue Service (IRS) will permit amendments as far back as the year of the marriage on the basis that neither spouse lawfully could have amended his or her tax returns prior to theWindsor decision. In either case, it will take some time for the IRS to develop policies and procedures to implement Windsor, and amended returns should be filed in accordance with applicable published guidance from the IRS, if available. In any situation where the limitations period is about to expire for a particular tax return, a married same-sex couple should consider filing a protective claim for a refund with the IRS in order to preserve the ability to obtain such a refund after the IRS has provided a means to amend the return.

6. Reside in a state that permits and/or recognizes marriages of same-sex couples. 

If a married same-sex couple was lawfully married in a jurisdiction that permitted the marriage but now reside in a state that does not permit and/or recognize the marriage, that couple should consider moving to a state that either permits marriages of same-sex couples or recognizes such marriages lawfully performed in other states if they wish to be certain to enjoy the federal benefits now potentially accorded to marriages of same-sex couples.

7. Non-citizen spouses should consider seeking permanent residency and/or becoming citizens. 

Until now, non-citizen spouses were not eligible for citizenship or permanent residency on the basis of their marriage to a spouse of the same sex who was a US citizen. As a result of the Windsor decision, however, non-citizens may be eligible for permanent residency and/or citizenship on that basis. Though there are many benefits to becoming a permanent resident or citizen, there are also numerous tax and non-tax consequences that should be carefully considered before making such an important decision.

Estate Planning Opportunities Arising from Perry 

California will now be required to permit marriages of same-sex couples, but other states that do not permit and/or recognize marriages of same-sex couples will not be required to do so. California married same-sex couples will enjoy all of the benefits available to married couples under federal law and thus should consider the above recommendations. In addition, married same-sex couples in California should consider the following recommendations:

1. Amend previously filed California income tax returns and/or file protective claims as appropriate. 

Married same-sex couples may be permitted to amend prior year California income tax returns to change their filing status and obtain a refund for any income taxes that were overpaid. Note that the normal limitations period for amending California returns expires four years after the original due date of the return (or the actual filing date if the return was put on extension) or one year from the date the tax was paid, whichever occurs later. If the limitations period for any particular tax return is about to expire, a married same-sex couple should consider filing a protective claim for a refund until such time as the State of California provides appropriate guidance for amending prior returns. Note that, as discussed above with regard to the limitations period for federal tax returns, it is conceivable that a married same-sex couple may be permitted to amend their returns through the first year of their marriage.

2. Amend previously filed tax returns and/or file protective claims with other states as appropriate. 

Married same-sex couples may also be entitled to amend prior gift tax and/or estate tax returns filed with other states that recognized marriage but not marriage equivalents (e.g., California registered domestic partnerships) at the time in question and receive a refund of taxes paid and/or reclaim any state gift tax and/or estate tax exemption. Again, the limitations period (if one applies) for amending such returns will vary by state. If the limitations period for any particular tax return is about to expire, a married same-sex couple should consider filing a protective claim for a refund until such time as the state provides appropriate guidance for amending prior returns.

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Is Regulation of Greenhouse Gases Through the Clean Air Act Becoming “Too Big to Fail”?

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In a much-publicized decision in 2007, the Supreme Court ruled that the United States Environmental Protection Agency (USEPA) is authorized to regulate greenhouse gases (GHGs) through the Clean Air Act. Massachusetts v. EPA, 549 U.S. 497 (2007). A slew of recent cases have rejected plaintiffs’ attempts to assert common law claims for damages based on the consequences of past emissions of GHGs. The courts generally have found that USEPA has occupied the role of regulating GHGs, and challenges to the agency’s actions must be brought through the appropriate administrative channels. As the Supreme Court weighs whether to grant certiorari in the Coal. for Responsible Regulation, Inc., et al. v. EPA, No. 09-1322 (D.C. Cir. June 26, 2012), the case that addresses four USEPA GHG rules, the Supreme Court may have difficulty in changing course from the idea that GHGs should be regulated pursuant to the Clean Air Act.

Comer v. Murphy Oil et al., No. 12-60291 (5th Cir. May 14, 2013).

In the aftermath of Hurricane Katrina, Mississippi Gulf residents sued numerous energy companies, alleging that the defendants’ emissions of GHGs exacerbated the severity of and damage caused by the Class 5 hurricane (hereinafter Comer I). The claims ranged from public and private nuisance, trespass and negligence, to fraudulent misrepresentation and conspiracy. The district court dismissed Comer I with prejudice, finding that the plaintiffs had no standing to bring these claims and the claims were non-justiciable because they involved a political question.

Comer I became mired in technical details and procedures, and ultimately the plaintiffs tried to refile the case to bring an entirely new lawsuit, Comer II. The Fifth Circuit dismissedComer II because the plaintiffs brought the same claims they alleged in Comer I, and the district court had already dismissed those claims on the merits. The court applied the doctrine of res judicata, which bars parties from litigating the same claim a second time, and, consequently, Comer II was barred by the district court’s original dismissal in Comer I. Because Comer I held that plaintiffs have no standing to challenge GHG emissions through common law claims, it supports the idea that GHGs should be regulated through the Clean Air Act, rather than addressed through litigation.

Native Village of Kivalina v. ExxonMobil Corp. et al., No. 09-17490 (9th Cir. Sept. 21, 2012).

Kivalina is a village located on the far northwest shore of Alaska. The village had long been protected by the winter ice that persisted and protected the land mass itself. Due to melting icebergs and rising sea levels, the village land mass is eroding, and remains unprotected by the ice wall for much of the year. The village almost certainly will be either eroded into nothingness or inundated by the Arctic Ocean in the next twenty years. Kivalina sued a large group of energy companies, alleging that the GHGs emitted by them resulted in global warming and their village’s imminent destruction. Under a theory of common law public nuisance, the village sought damages to allow the relocation of the community.

The District Court held that political questions such as those raised by the allegations were not justiciable. Further, the court held the plaintiffs lacked Article III standing because they could not show that the named defendants likely caused the injuries, nor could the injuries be traced to an act of any of the defendants.

The Ninth Circuit agreed but expounded on the role of federal common law in pollution cases. The Court noted that federal common law has developed to fill gaps arising in cases of transboundary pollution and that those cases generally arise as nuisance claims. Despite its acknowledgement that nuisance claims can be used to regulate pollution, the Ninth Circuit explained that where a statute directly addresses the underlying issue, developing a federal common law was not necessary to address the issue. Accordingly, because the Supreme Court found that Congress acted through the Clean Air Act to address GHG pollution inMassachusetts v. EPA, filling the gap with federal common law (or public nuisance claims) was not necessary. Furthermore, the Ninth Circuit found that federal common law does not fill a gap solely based on the type of relief requested. In other words, the plaintiffs inKivalina sought damages rather than emission reduction, the latter being the type of relief afforded by the Clean Air Act. Although the plaintiffs’ requested relief was not available under the Clean Air Act, the Clean Air Act still displaced federal common law and prevented plaintiffs from seeking damages through a common law claim (such as public nuisance).

Consequently, Kivalina, like Comer, supports the idea that USEPA is charged with regulation of GHGs through the Clean Air Act.

Public Trust Doctrine Cases

Along a similar avenue, a number of public trust doctrine cases have been filed on behalf of children since 2011. In these cases, the plaintiffs allege that children’s futures are being affected by the lack of action to regulate GHGs, and they request that the various agencies cited in the lawsuits — primarily USEPA and Department of the Interior — take immediate action to reduce GHGs. These cases use the public trust doctrine as the basis of the complaint by alleging that the atmosphere is a common resource that must be managed for the public good and the agencies have failed to properly manage that resource. These cases have generally been dismissed for failure to state a claim for which relief can be granted.See Alec L. v. Perciasepe, No. 11-cv-2235 (D.D.C. May 22, 2013); Sanders-Reed v. Martinez, No. D-101-cv-2011-01514 (D.N.M. July 14, 2012); Alec L. v. Jackson, No. 1:11-cv-02235 (D.D.C. May 31, 2012); Loorz v. Jackson (D.D.C. April 2, 2012); Filippone v. Iowa Dep’t of Natural Resources, No. 2-1005, 12-04444 (Iowa Ct. App. Mar. 13, 2013); Aronow v. State, No. A12-0585 (Minn. Ct. App. Oct. 1, 2012).

In general, cases arising under the public trust doctrine face two challenges. First, the Supreme Court held in PPL Montana, LLC v. Montana, No. 10-218 (2012), that the public trust doctrine is a matter of state, not federal, common law and so a federal claim is not justiciable in federal court. Second, in AEP v. Connecticut, No. 10-174 (2011), the Supreme Court held that the role of regulating GHGs, and any consequence(s) of GHGs, has been occupied by the Clean Air Act and therefore challenges to the regulation of GHGs should be brought through the Clean Air Act rather than through a common law claim. Again, these cases are important for the future of GHG regulation because they affirm the agency’s role as the regulator of GHGs through the Clean Air Act.

Montana Envt’l Info. Center v. U.S. Bureau of Land Mgmt., No. cv-11-15-GF-SEH (D. Mont. June 14, 2013).

In another case affirming the role of the Clean Air Act in regulating GHGs, environmental groups claimed that the Bureau of Land Management (BLM) failed to adequately consider climate change, global warming, and the emission of GHGs in violation of the National Environmental Policy Act (NEPA) before approving oil and gas leases on federal land in Montana in 2008 and 2010. The environmental groups argued that BLM’s failure to follow NEPA procedures would result in emissions of methane gas from the oil and gas leases at issue. The release of methane gas would cause global warming and climate change, which would present a threat of harm to their aesthetic and recreational interests in lands near the lease sites by melting glaciers, warming streams, and promoting the destruction of forests through the proliferation of plagues of beetles.

The district court dismissed the lawsuit because the environmental groups lacked standing to bring the claim. The court found that the environmental groups failed to demonstrate that BLM’s alleged failure to follow proper procedure created an increased risk of actual, threatened, or imminent harm to their recreational and aesthetic interests in lands near the lease sites. Although the environmental groups had local recreational and aesthetic interests at heart, the court found that the effects of GHG emissions are diffuse and unpredictable, and the groups presented no scientific evidence or recorded scientific observations to support their assertions that BLM’s leasing decisions would present a threat of climate change impacts on lands near the lease sites. Furthermore, the environmental groups did not show that methane emissions from the lease sites would make a meaningful contribution to global GHG emissions or global warming. The court therefore found that the environmental groups failed to establish injury-in-fact and causation. As a result, the court foreclosed another potential avenue for litigating claims surrounding GHG emissions, and potential plaintiffs now seem to be left only with direct challenges to USEPA’s regulations (or lack thereof).

Conclusion

The Court would mark a dramatic shift if it moved away from these cases. By the time the Supreme Court has the opportunity to review climate change regulation again, the Obama administration may have set a “too big to fail” bar with its climate policies. Regardless of what happens in the future, however, as of today, the Court’s decision in Massachusetts v. EPA appears to have had a pronounced impact, acceding to USEPA the authority to regulate GHGs through the Clean Air Act, and denying common law remedies for impacts tied to climate change.

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Eleventh Hour Fiscal Cliff Deal – What Does it Mean for Canadians?

Altro Levy LogoJust hours before midnight on New Years Eve, the US Senate hammered out a tentative deal to avoid sending the country over the Fiscal Cliff. Yesterday, a reluctant, Republican-controlled House of Representatives has also blessed the plan, which deals with many of the major tax issues at stake, while pushing back the spending issues to later into the new year.

The “Fiscal Cliff”, a term coined by Ben Bernanke, the Chairman of the Federal Reserve, refers to the cumulative effect of spending cuts and tax increases, which were scheduled to occur January 1, 2013 as a result of the expiry of several pieces of legislation. The issue has received a great amount of press in recent months, as commentators continued to hope that Congress would agree on compromise legislation to soften the economic blow. In this post, we will outline the primary cross border tax impacts on Canadians.

Federal Estate Tax

For Canadians with interests in the US, the primary consequence of going over the Fiscal Cliff would relate to the federal estate tax. The Canada – US Tax Treaty allows Canadian residents to piggy-back onto some estate tax exemptions that are available to US citizens and residents. In particular, in 2012, there was a $5.12 million exemption from estate tax, such that only estates worth greater than that amount would end up paying taxes, and the maximum rate was capped at 35%. The looming Fiscal Cliff threatened to bring us back to the $1 million exemption amount at maximum rate of 55%, which was in effect when President Bush took office in 2001. Note that this is not a capital gains tax on death, as we have in Canada. This tax applies to the fair market value of assets at the time of death.

The good news for Canadians is that the deal will extend the $5.12 million exemption amount, which will increase with inflation. The maximum rate will increase to 40% on a permanent basis. As a consequence, if a Canadian owns US assets (such as real estate or US securities) worth more than $60,000, and passes away with a worldwide estate valued in excess of $5.25 million, some US estate tax is likely going to be payable. It is important to note that the worldwide estate value includes everything: real estate, investment accounts, RRSPs, business interest, even the proceeds of life insurance. However, the tax is only applied against the value of the US situated assets, and some tax credits ought to be available under the Tax Treaty thanks to the extension of the high exemption amount.

Nonetheless, it remains worthwhile for high-net worth Canadians to evaluate their estate tax exposure and hold US assets in Cross Border structures that minimize or eliminate the potential for US estate tax liability.

Income and Capital Gains Tax

Most of the press on the Fiscal Cliff has centered on the increases in income tax rates. This issue is very unlikely to cause Canadian residents much concern, even though US income tax may be payable. Since Canadian residents pay Canadian tax on their world wide income, any US source income earned by a Canadian will be added on the top of their Canadian income, such that it will be taxed at a relatively high marginal rate. In contrast, that same US sourced income will be taxed in the US at the lower marginal rates, and Canada will give a credit for US tax paid. As such, as long as the marginal rate in the US is lower than the marginal rate in Canada on the same income (which it clearly will), increases in US income tax rates will not be noticed by Canadians when the dust settles at the end of a tax year.

One expiring tax cut that was not renewed under the Eleventh Hour Deal relates to the long-term capital gains tax rate on the disposition of capital assets. This is one tax increase that will be felt by some Canadians. In Canada, we pay regular income tax on half of the capital gain. As such, if the gain pushes a taxpayer into the top marginal rate in Canada, the effective capital gains tax rate ranges from approximately 19.5% in Alberta to almost 25% in Quebec. In 2012, the US federal capital gains tax for individuals who had held an asset for longer than one year was capped at 15% on the gain. That rate has increased to 20% with the Fiscal Cliff Deal (high income earners will pay 23.8% including an “Obamacare” surcharge). Where state-level tax also applies, the US capital gains tax may well exceed that owed in Canada, resulting in a higher overall tax burden. For example, California has a state capital gains tax rate of 9.3%. Therefore, any Canadian selling a California property will owe more tax to the US (combined rate of 29.3%) than to Canadian jurisdictions. Other states have a lower rate of tax, such that the effective US rate may not exceed the Canadian rates. For example, Florida does not impose a capital gains tax on individuals, trusts, or limited partnerships.

Market Volatility

The other aspect of the Fiscal Cliff that may affect Canadians is the most difficult to anticipate. Many economics were predicting that the overall effect of the Fiscal Cliff would send the US back into recession. This was the concern that prompted Bernanke and others to characterize the issue as a ‘cliff’ connoting catastrophic economic consequences. While the economy should respond favorably to the agreement that Congress passed, there are many pressing issues that were simply deferred in this week’s deal. Many of the spending cuts, which are thought to jeopardize the economic recovery, were pushed back two months for Congress to resolve later on. If worst fears are realized, the value of many US assets may decline as economic conditions generally erode.

As cross border tax and estate planners, we often advise Canadian clients to consider repositioning their investment portfolios to exclude directly held US securities because of the US estate tax exposure they represent. If you believe that the fiscal transition will negatively impact the value of US securities, it may be a good time to discuss repositioning with your investment advisor.

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Takeover Code Amendments Extend the Rights of Pension Scheme Trustees

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Amendments include new requirements regarding offerors’ intentions, documents provided to trustees, trustees’ opinions on offers, and publication of agreements between offerors and trustees.

On 22 April, the Code Committee of the UK Panel on Takeovers and Mergers (the Panel) published response statement RS 2012/2 (the Response Statement), which introduces amendments to the City Code on Takeovers and Mergers (the Code).[1] The Response Statement follows a consultation to consider extending the rights of trustees of offeree company pension schemes. Broadly, the amendments to the Code provide the following:

  • An offeror is required to state its intentions with regard to the offeree company’s pension scheme.
  • Certain information is required to be published in the offer document or otherwise provided to pension scheme trustees.
  • Trustees are allowed to provide an opinion on the effects of an offer on the company’s pension scheme.
  • Agreements between an offeror and pension scheme trustees that relate to pension scheme funding may be required to be published if they are material.

Background

On 19 September 2011, significant changes were made to the Code, including an extension of the obligations of the offeror and offeree in relation to information to be provided to, and the obligation to publish opinions of, the offeree company’s employees and employee representatives. During the Panel’s consultation on those changes, the pensions industry lobbied significantly for similar provisions to be added to the Code in relation to trustees of pension schemes. Proposed amendments to the Code were published in public consultation paper PCP 2012/2 (the PCP)[2] on 5 July 2012, and a period of consultation followed. The Response Statement sets out the Panel’s response to that consultation and the resulting changes to be made to the Code. Although many of the changes will be adopted as originally proposed in the PCP, certain modifications have been made.

In determining the new regime, the Panel has been mindful that the intended effect of the changes is to create a framework within which the effects of an offer on an offeree company’s pension scheme can become (i) a debating point during the course of the offer and (ii) a point on which the relevant parties can express their views.

Application of New Code Provisions to Defined Benefit Schemes

The new provisions of the Code are limited to funded pension schemes sponsored by the offeree (or any of its subsidiaries) that (i) provide pension benefits (either in whole or in part) on a defined benefit basis—and (ii) have trustees (or managers, in the case of non-UK schemes). The Code provisions are not limited to UK pension schemes and apply to all such schemes, regardless of size or materiality in the context of the offeree’s group.

The new provisions do not apply to pension schemes that provide pension benefits only on a “defined contribution” basis, as the Panel believes that the provisions of the Code granting rights to employees and employee representatives already create an appropriate framework for discussion in relation to the impact of an offer, and the offeror’s intentions, in relation to such schemes.

Publication of Offeror’s Intentions in Relation to Pension Scheme

An offeror will now be required to include in the offer document a statement of its intentions with regard to relevant offeree pension schemes, including with respect to employer contributions and arrangements for deficit funding, benefits accruals for current members, and the admission of new members to the scheme. However, the Panel has not required that the offeror include a statement on the likely repercussions of its strategic plans for the offeree company on relevant pension schemes. Similarly, the Panel has confirmed that such statements do not need to include an assessment of the future ability of the offeree company to meet its funding obligations to its pension scheme.

The Panel also confirmed that the general rule under Note 3, Rule 19.1 of the Code will apply to statements of intention made in respect of pension schemes. This means that an offeror will be considered to be committed by any such statements for 12 months after the offer ends (or such other period of time as is specified in the offeror’s statement), unless there has been a material change of circumstances.

Under the PCP, the Panel originally proposed to require the offeree to include in its offeree circular its views on the effects of the implementation of the offer—and the offeror’s strategic plans for the offeree—on the offeree’s pension schemes. However, following the consultation, the Panel did not make these changes but did confirm that the offeree board may include its views on these subjects in the offeree circular should it wish to do so.

Provision of Information to Pension Scheme Trustees

The amendments to the Code provide that trustees of the offeree company’s pension scheme will be entitled to receive the same documents that offerors and offerees are required to make available to employee representatives. These documents include the following:

  • The announcement that commences the offer period
  • The announcement of a firm intention to make an offer
  • The offer document
  • The offeree board circular in response to the offer document
  • Any revised offer document
  • The offeree board circular in response to any revised offer document

Pension Scheme Trustees’ Opinion on the Offer

Under the revised Code, pension scheme trustees will have the right to require the offeree’s board of directors to publish the trustees’ opinion on the effects of the offer on the pension scheme, and the offeree will be obliged to notify such trustees of this right at the commencement of the offer. As with employee representatives’ opinions, if the trustees’ opinion is received in good time, the opinion must be appended to the offeree board circular. If it is not received in good time, it must be published on a website, with such publication to be announced on a Regulated Information Service.[3] The Panel has confirmed that the trustees’ opinion may cover more than the impact of the offer on the benefits that the scheme provides to members (and other matters to be included in the offeror’s statement in the offer document) and that the opinion may also extend to the trustees’ views on the impact of the offer on the post-offer ability of the offeree company to make future contributions to the pension scheme (i.e., the strength of its funding covenant).

Unlike employee representative opinions, the offeree will only be responsible for the costs incurred in the publication of the trustees’ opinion and not for any other costs incurred in relation to its preparation or verification.

Agreements Entered into Between an Offeror and Pension Scheme Trustees

The revised Code also contains certain provisions relating to any agreements between an offeror and the trustees of an offeree pension scheme, for example, in relation to the future funding of that scheme. Following the consultation, the Panel determined that any such agreements should be treated in the same manner as any other offer-related agreement, with certain variations. As a result, the amendments contain the following requirements for agreements between offerors and pension scheme trustees:

  • Where any such agreement is a material contract for the offeror within the meaning of the Code, it should be published on a website in the same manner as any other material contract.
  • Where such an agreement is not material, but is nevertheless referred to in the offer document, there will be no requirement to publish it on a website.
  • Where such an agreement relates only to the future funding of the pension scheme, it will be excluded from the general prohibition on offer-related agreements contained in Rule 21.2(a).[4]

Pensions Regulator

The Panel has confirmed, following discussions with the UK Pensions Regulator, that there will be no obligation under the Code for the offeror or offeree to send offer-related documentation to the Pensions Regulator, nor will there be any obligation on the Panel to notify the Pensions Regulator of takeover offers. Accordingly, it is for the offer parties (and any other interested parties) to decide whether they wish to engage with, or seek clearance of the offer from, the Pensions Regulator.

Entry into Force

The amendments introduced by the Response Statement will take effect on 20 May 2013, and an amended version of the Code will be published on this date.


[1]. View the Response Statement here.

[2]. View the PCP here.

[3]. The UK Financial Conduct Authority has published a list of information services that are approved Regulated Information Services in Appendix 3 of the Listing Rules, which is available here.

[4]. The Panel, however, emphasised that any obligations or restrictions on the trustees regarding any other offeror or potential offeror would not be permissible.

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Considerations For International Clients Who Intend to Buy A Home In the U.S.

Sheppard Mullin 2012

International buyers invested $82.5 billion in U.S. residential real estate (4.8% of total U.S. sales) according to the most recent survey conducted by the National Association of Realtors for the 12 month period ending with March 2012. According to that survey, the top states in the U.S. for international buyers were Florida, California, Arizona and Texas. That survey also finds that the top-five international buyers were from Canada, China, Mexico, India, and the United Kingdom and that Brazil also remains a major source of purchasers. Homes are bought in the U.S. for investment, vacation-use, temporary use for professional, educational (which could include providing a home to a child who is pursuing his or her education in the U.S.), and a myriad of other reasons.

U.S. home buying and ownership, without proper planning, can have unexpected and unintended consequences. Many international clients are not aware that ownership of a U.S. home triggers U.S. estate tax on death and a gift of the property during lifetime triggers U.S. gift tax. U.S. estate and gift tax is imposed at a rate of 40%. An individual who is neither a U.S. citizen nor domiciled in the U.S. can shelter only $60,000 of U.S. situs assets on death (i.e. assets located or deemed to be located within the U.S.). In terms of gifting, an individual who is neither a U.S. citizen nor domiciled in the U.S. can make annual exclusion gifts of $14,000 per year to anyone and can currently pass $143,000 per year to a spouse who is not a U.S. citizen free of gift tax. That is in contrast to the $5,250,000 that a U.S. citizen or domiciliary can pass free of estate tax on death or by gift during lifetime as well as unlimited transfers to a U.S. citizen spouse.

To avoid triggering U.S. estate tax on death, many international clients are counseled to take title to the home in a foreign “blocker” corporation which, if respected, is not subject to U.S. estate tax on death. This form of title has the added advantage of providing anonymity and liability protector to the shareholder . Owning a home in a foreign corporation triggers other more immediate tax concerns such as application of the corporate tax rate (up to 35%) in lieu of the preferential long-term capital gains rates on sale (up to 20%), possible imputed rental income for use of corporate property by the shareholder, loss of step-up in the income basis of the home on the death of the owner (the basis of the stock in the corporation would be adjusted but the inside basis—the home itself would not be entitled to a basis adjustment), and loss of the ability to avoid the home being reassessed for California real property tax purposes on transfer from parent to a child. In addition, a U.S. person who will inherit shares in a corporation that will either become a Controlled Foreign Corporation (CFC) or a passive foreign investment company (PFIC) faces numerous special compliance obligations and substantive tax issues as a result of the ownership of those shares. There are many other ways to take title, such as through a LLC or a trust and each option should be explored in depth to achieve the client’s objectives to the maximum extent possible. Consideration should also be given to planning aimed at avoiding a public court proceeding that would be necessary to convey title to the beneficiaries of an international client who dies holding title directly to a U.S. home.

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Estate Planning with Digital Assets in Mind

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“It’s ‘Bosco’!!”  Seinfeld fans will recall from “The Secret Code” episode that George Costanza created a good deal of chaos by being reluctant to share his secret code.  By the same token, failing to share the secret codes to your digital assets could put a wrench in your best laid estate plans.  This article will discuss various measures that you can implement to insure that your digital assets will pass in accordance with your desires.

Whether we like it or not, the world is changing at warp speed.  Paper statements for bank accounts and the like are going to the way of the dodo bird.  Those dusty old books that used to gobble up shelf space can now be stored on a device that fits in the palm of your hand.  Same goes for the vinyl records you bought with money from mowing lawns.  And who would have ever thought that you’d be able to share pictures of your children or grandchildren with your friends and family by posting them on Facebook?

As the world becomes more and more digital, so too do the assets which comprise your estate.  Digital assets encompass a wide variety of items.  The website www.digitalestateresourse.com defines digital assets to include the following:

  1. files stored on digital devices, including but not limited to, desktops, laptops,    tablets, peripherals, storage devices, mobile telephones, smartphones, and any    similar digital device which currently exist or may exist as technology develops;    and
  2. e-mails received, e-mail accounts, digital music, digital photographs, digital    videos, digital books, software licenses, social network accounts, file sharing    accounts, financial accounts, banking accounts, tax preparation service accounts,    online stores, affiliate programs, other online accounts, and similar digital items    which currently exist or may exist as technology develops, regardless of the    ownership of the physical device upon which the digital item is stored.”

Failing to properly catalogue your digital assets could have a variety of negative consequences.  By way of example, that rainy day savings account that you never told anyone about could go undetected by the executor of your estate; and those vacation photos which your family would so enjoy could be forever locked in a Shutterfly account.

So what needs to be done to insure that your digital assets are properly accounted for and that they go to their intended beneficiaries?  Taking the following steps will go a long way towards accomplishing your objectives: (1) keep a master list of your digital assets; (2) keep the master list current; (3) tell someone where you keep the master list; (4) determine whether your digital assets are transferable; and (5) consider making specific provisions for them in your Will.

(1) KEEPING A LIST.  The most important step in properly handling your digital assets is to create a master list of such assets.  I find Excel spreadsheets to be a helpful tool for creating and maintaining such lists.  For each of your digital assets, consider including the following information: (i) a description of the asset (e.g., TD Ameritrade Brokerage Account); (ii) where the asset is located (e.g.,www.tdameritrade.com); (iii) any account number or user name associated with the asset; and (iv) any password that is necessary to gain access to the asset.

(2)  CURRENT INFORMATION.  Creating a list of digital assets without keeping the information current is about as useful as having an ashtray on a motorcycle.  It doesn’t do your executor any good to know that the brokerage account you opened in 2004 was with TD Ameritrade.  Rather, he really needs to know that you transferred the assets to Fidelity Investments in 2009 and that is where the assets are currently located.  Ideally you should update the master list every time you change the location of the assets, change a password or make a similar change.  Short of that, you should review your master list at least once every three months and after you have done so, make a notation to that effect on the master list.  Something such as “Current as of 12/1/12” would work nicely.

(3)  LOCATION OF THE LIST.  Creating and maintaining the master list does your heirs no good unless you share its location with someone you trust.  As a best practice, you should tell your executor where the master list is located and you should keep a copy of the master list with your other valuable papers and documents.

(4)  NOT ALL DIGITAL ASSETS ARE TRANSFERABLE.  Unless you are the one person in 10,000 who actually reads the user agreement when you establish an online account, you should revisit each user agreement for your online accounts to determine which of your digital assets are transferrable upon your death.  By way of example, not all airlines permit the transfer of frequent flyer miles upon the death of the account holder.  Upon making such a determination, you should update your master list accordingly.

(5)  SPECIFIC BEQUESTS OF DIGITAL ASSETS.  Now that your executor knows your digital assets exist, they should pass in accordance with your overall estate plan.  Without making specific provisions for your digital assets, they will pass pursuant to the residuary clause of your Will.  So, while it is not necessary to make specific bequests of your digital assets, as a practical matter it may be advisable to do so.  For example, I know that my wife would love to have the family photos stored on my laptop, but I can promise you that she has no interest in the Alex Cross novels I’ve purchased for my Kindle Fire or the Johnny Cash albums I’ve purchased for my iPhone.

Digital assets are often an overlooked component of even the most complicated estate plans.  However, with proper planning you can make sure that all of your digital assets are properly accounted for and that they pass according to your wishes.  To assess the current health of your estate plan, including a determination of whether your digital assets are properly accounted for, consider scheduling an appointment with your estate planning attorney.

© 2013 by McBrayer, McGinnis, Leslie & Kirkland, PLLC

The Effect of the Fiscal Cliff Deal on Estate Planning

An article by Susan C. Minahan with Michael Best & Friedrich LLPThe Effect of the Fiscal Cliff Deal on Estate Planning, was recently featured in The National Law Review:

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In an attempt to avert the “fiscal cliff” at the end of 2012, the American Taxpayer Relief Act of 2012 (the “2012 Act”) was passed by Congress on January 1, 2013, and signed into law by the President on January 2, 2013. The 2012 Act has significant impact on all taxpayers, and is a game changing piece of legislation in the estate, gift, and generation-skipping transfer tax area.

The 2012 Act permanently extends the $5,000,000 unified federal estate, gift, and generation skipping transfer (GST) tax exemptions implemented under the 2010 Tax Relief Act for all such transfers occurring after December 31, 2012. All three exemptions are indexed for inflation. As a result, the exemption amounts in 2013 are $5,250,000. The 2012 Act increases the maximum tax rate from thirty-five percent (35%) to forty percent (40%) for any transfers in excess of the exemption amounts.

The 2012 Act also permanently extends portability of unused estate tax exemption for married couples. Portability, a concept introduced in the 2010 Tax Relief Act, allows a surviving spouse to “port” or add a deceased spouse’s unused estate tax exemption amount to the surviving spouse’s exemption amount without the use of a traditional credit shelter trust. However, portability, as noted in our client alert dated December 20, 2010, should not be solely relied on as an estate planning substitute for several reasons. First, the ported amount can be lost if the surviving spouse remarries. Second, portability does not provide the same asset protection after the first spouse’s death that is provided by traditional credit shelter trust planning. Third, portability does not apply to the GST exemption; therefore, to leverage GST planning, careful dynasty trust planning is still necessary.

It should be noted that the exemptions are “permanent” only as long as Congress chooses not to change them (no tax law change should ever be considered “permanent” with a new Congress every two years).

In light of the 2012 Act and the current estate planning environment, estate planning is still necessary, and the following are continuing opportunities for transferring wealth:

Low Interest Rate Planning

Historically low interest rates continue to present the opportunity for intra-family low interest loans or refinancing of low interest intra-family loans. The January 2013 mid-term applicable federal rate (for 3-9 year loans) is 0.87%. Low interest rate loans can also be combined with gifting, resulting in larger tax free transfers. Sales to intentionally defective grantor trusts (IDGTs) and grantor retained annuity trusts (GRATs) are commonly used techniques for this type of planning, and the 2012 Act fortunately did not impose limits on GRATs, IDGTs or valuation discounts that had been proposed earlier. Congress may impose limits on the use of these techniques in the future, but at least for the time being, the window of opportunity for these techniques remains open.

GST Planning

Dynasty trusts that utilize the GST exemption can be used to transfer assets from generation to generation for multiple generations of a family, avoiding estate, gift, and GST tax at each generation. With the high exemptions, a single person can protect $5,250,000 and a married couple can protect $10,500,000, indexed for inflation, in this manner. In addition, as previously noted, GST exemption is not “portable” and therefore, dynasty trusts are important for married couples in protecting the GST exemption of each spouse. Limitations on the number of years a dynasty trust can run were also not part of the 2012 Act.

Asset Protection

Trusts remain an important part of estate planning, even for smaller estates, because they provide means of asset protection. Trusts can be used to protect assets from a beneficiary’s creditors, including a divorcing spouse. Trusts can also protect assets in the event a beneficiary becomes disabled. Lifetime irrevocable trusts also provide an estate and gift tax “freeze” for a donor’s estate at the value of the trust as of the date of the lifetime gift.

Annual Gifts

In addition to the lifetime gift tax exemption, each taxpayer may make annual exclusion gifts to any number of donees. The annual exclusion was indexed for inflation with the 2001 Act, and in 2013 the annual gift tax exclusion amount is $14,000 per donee.

The following are some other notable provisions of the Act that impact individuals:

  • Extends tax cuts for individuals with incomes under $400,000 and married couples under $450,000;
  • Raises the ordinary income tax rate from 35% to 39.6% for individuals with income over $400,000 and married couples with income over $450,000;
  • Raises capital gains and dividend tax from 15% to 20% for individuals with income over $400,000 and married couples with income over $450,000;
  • Overall limit on itemized deductions are reinstated for individuals with income over $250,000 and married couples with income over $300,000, which may impact lifetime charitable giving plans;
  • Permanently indexes the alternative minimum tax (AMT) for inflation;
  • Expands employees’ ability to convert traditional retirement accounts such as 401(k)s and 403(b)s into Roth accounts; and
  • Extends through 2013 the tax free IRA “rollover” to qualifying charities after age 70½ (Note: special rules relate to actions that may be taken in January of 2013 to treat contributions as being made during 2012).

© MICHAEL BEST & FRIEDRICH LLP