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Lisa Newfield, White Plains lawyer, Estate Planning for the Small to Mid-Size Estate

Estate Planning For The Small to Mid-Size Estate:

To Credit Shelter or Not to Credit Shelter: Renunciation

I. What is a Small to Mid-Size Estate?

Since the enactment of The Economic Growth and Tax Relief Reconciliation Act of 2001, P.L. 107-16 (June 7, 2001) (“EGTRRA”), the definition of small to mid-size estate for estate tax planning purposes has been changing.

As of January, 2004, the federal applicable exclusion amount was increased to $1.5mm for all persons dying after December 31, 2003 and the amount remains at $1.5mm for all persons dying in 2005. The exempt amount is set to increase to $2mm for all deaths after December 31, 2005.

New York couples with a gross estate of no more than $1.5mm no longer have much need for federal estate tax planning in their wills, given the increase in the applicable exclusion amount.

New York couples with a gross estate of $1.5mm - $3mm should still consider estate tax planning as part of their estate plan; however, the primary focus should be on deferring the New York Estate Tax.

II. Highlights of EGTRRA.

In addition to the increase in the federal applicable exclusion amount, other aspects of the federal estate tax law changed under EGTRRA as well: 

1. Reduction in Rates of Tax.

· 2005 maximum estate tax rate is 47%, and set to decrease to 46% in 2006 and 45% in 2007-2009;

· Generation-skipping Transfer (“GST”) tax rate is the maximum estate tax rate in effect; and

· Gift tax rate is the maximum estate tax rate in effect through 2009, and then the gift tax rate becomes flat tax of 35%. Gift tax is not repealed under EGTRRA. Gift tax applicable credit is limited to $1mm.

2. GST Tax Exemption through Year 2009.

· The GST tax exemption increased to equal that of the applicable exclusion amount for generation-skipping transfers made after December 31, 2003.

3. State Death Tax Credit

· Under EGTRRA, the maximum credit allowed on the federal estate tax return for estate taxes paid to states is reduced over a four year period to zero.

· As of 2005, no state death tax credit allowed on federal estate tax returns, but is replaced by a deduction.

· The significance for credit shelter planning of this change in the structure of the state death tax credit is not so much the effect of the reduction in rates, but more the impact of the amount of credit shelter protection afforded under various state laws. As a result of the change in the federal law, many states no longer mirror the amount of the federal protection and this decoupling of the federal and state tax systems may create a situation where the full use of the federal credit will require payment of state estate tax. For states like New York, whose estate tax is tied to the federal law in effect in 1998, the state credit protection will be limited to $1mm, even though the federal applicable exclusion amount will be $1.5mm.

4. Carryover Basis.

· Under EGTRRA, during repeal of the estate tax, year 2010, beneficiaries will inherit property with the lesser of decedent’s cost basis or fair market value of the property, subject to a few adjustments. A detailed explanation is beyond the scope of this outline.

III. Tax Planning for Mid-Size New York Estates.

Estate planning for a New York couple with a gross estate valued at $1mm - $3mm, the focus of any tax planning should be with regards to the deferral or avoidance of the New York estate tax.

Unlike the federal scheme, non-payment of state estate tax at the death of the first spouse to die may not be a deferral of the New York estate tax, but actual avoidance (i.e. if the surviving spouse moves to a state which does not impose a state estate tax, such as Florida).

When drafting a will, depending on the client and the client’s goals, use of a disclaimer trust or a credit shelter trust may be appropriate. Further, it would be advisable to modify the credit shelter formula to make the bequest to the credit shelter trust equal to an amount that can pass free of federal and state estate tax.

A. Disclaimers

Disclaimers generally have been used in post mortem planning, as a remedial measure to “fix” a will; however, given the current estate tax system, the planned use of disclaimers in an estate plan is becoming more frequent.

From a tax perspective, disclaimers permit the transfer of the disclaimed assets to someone other than the initial beneficiary without the imposition of gift tax on the disclaiming beneficiary. In order for disclaimers to be qualified, the state and federal law requirements must be met.

1. Federal Requirements (IRC §2518)

i. no acceptance of benefits.

ii. written refusal.

· must state disclaimer is irrevocable;

· interest must be described; and

· acknowledged.

iii. nine months.

· with nine months after the later of the creation of the interest – death of testator – or age 21 of disclaimant.

iv. no direction by disclaimant.

· disclaimant cannot direct to whom the disclaimed property will pass. The property will simply pass as it would have if the disclaimant had predeceased the decedent, or as otherwise provided by the decedent’s will; and

· disclaimed interest must pass to someone other than disclaimant, except in the case of the decedent’s spouse.

2. New York Requirements (EPTL §2-1.11)

i. no acceptance of benefits;

ii. written acknowledged refusal must be filed with Surrogate’s Court;

iii. nine months;

iv. affidavit by renouncing party, including copy of written renouncement as served personally on fiduciary of estate/trust or upon any other person having custody of legal possession of or legal title to property and by mail on person(s) whose interest may be increased by disclaimer;

v. disclaimant may not accept property; and

vi. disclaimer is irrevocable.

3. Who Can Disclaim under New York Law (EPTL §2-1.11(c))

· individuals (beneficiary);

· New York permits guardians and conservators if authorized by the Court that appointed them;

· Executor of decedent if authorized by the Court having jurisdiction of estate of decedent; and

· Attorney-in-fact, when so authorized under a duly executed power of attorney, provided, however, that any renunciation by an attorney-in-fact of a person under disability shall not be effective unless it is further authorized by the Court, and, provided, further, that a renunciation by an attorney-in-fact of a person not under disability may be made without court authorization, unless the property which would have passed under said renunciation is, by reason of said renunciation, disposed of in favor of such attorney-in-fact or the spouse or issue of such attorney-in-fact, in which case such renunciation shall not be effective unless either (A) the instrument appointing such attorney-in-fact expressly authorizes a renunciation in favor of such attorney-in-fact or the spouse or issue of such attorney-in-fact, or (B) such renunciation has been authorized by the Court with which such renunciation must be filed.

4. Partial Disclaimers.

Disclaimers may be made of partial interests in property. Individuals may disclaim a pecuniary amount. Certain powers may also be disclaimed, such as power of appointment under a trust.

5. Surviving Spouse as Disclaimant with Disclaimed Assets Passing to “Disclaimer Trust”

· For midsize estates, depending on the age and needs of the client, a disclaimer trust may be a useful tax planning tool.

· Although the “no-interest rule” does not apply to a spouse who disclaims a transfer from a spouse, the “non-direction rule” does apply. As a result, the surviving spouse can disclaim an outright bequest under the deceased spouse’s will even though the disclaimed bequest falls into a residuary or fall-back trust (i.e. Disclaimer Trust) that benefits the surviving spouse. However, because the disclaimed interest must pass without any direction by the disclaimant, including the spouse of the decedent, the spouse cannot have certain interests or powers with respect to the Disclaimer Trust.

· The spouse cannot have the right to direct the beneficial enjoyment of the disclaimed property in a transfer that is not subject to a federal estate and gift tax. Reg. §25.2518(e)(2). The spouse cannot have an inter vivos or testamentary special or limited power of appointment.

· Spouse cannot have a general power of appointment.

· If the spouse is the trustee of the Disclaimer Trust, the spouse can have discretionary powers to benefit herself and others if the discretionary powers are governed by an ascertainable standard. Reg. §25.2518(e)(5), Example 5.

· Spouse can be the income beneficiary.

· Spouse can be the beneficiary of trustee’s discretionary power to invade corpus, whether or not that power is limited by an ascertainable standard. Reg. §25.2518(e)(5), Example 6.

· Spouse can have a 5 x 5 power. Reg. §25.2518(e)(5), Example 7.

· If spouse disclaims and the disclaimed assets pass to a trust which gives the spouse powers she is not allowed to have under a qualified disclaimer, she must disclaim the power(s) over that portion of the trust that is attributable to the disclaimed property passing to the trust. The regulations direct that this portion be determined by a fraction, the numerator which is the fair market value of the disclaimed property on the date of the disclaimer and the denominator of which is the total fair market value of the trust immediately after the disclaimer.

6. Disclaiming a Fiduciary Power

· When it is a trustee who is disclaiming a fiduciary power beneficial to trust beneficiaries, Rev. Rul. 90-110 makes it clear that appropriate authorization must be obtained if the disclaimer is to be a qualified disclaimer.

· A fiduciary may want to disclaim fiduciary powers to clean up a trust for a marital or charitable deduction or other tax purposes. Under trust law, just as a fiduciary cannot resign without court approval or authorization by the will or trust under which the fiduciary acts, so a fiduciary cannot disclaim a power without court approval or authorization by the instrument under which the fiduciary acts. Even if a fiduciary can disclaim a fiduciary power, her disclaimer does not bind successor fiduciaries, unless the instrument under which the fiduciary acts makes the disclaimed power personal to that fiduciary or unless the power still exists because it is exercisable by co-fiduciaries. Moreover, a fiduciary cannot disclaim a power beneficial to a beneficiary so as to cause detriment to that beneficiary, unless the will or trust permits or the beneficiary consents by executing a disclaimer herself.

7. Medicaid Planning with Disclaimers

· Disclaimers, while a valuable and flexible tool for estate planning, may not be the best plan for a couple contemplating Medicaid planning. Pursuant to 96 ADM 8, renouncing an inheritance constitutes a transfer of assets for Medicaid eligibility purposes.

· Medicaid deems a disclaimer as a transfer of assets for which a penalty is assessed. The date of the transfer would be deemed to be the date of the disclaimer.

· However, a disclaimer of a partial interest by a surviving spouse on Medicaid may allow some Medicaid and tax planning. The amount disclaimed is deemed a transfer which results in a penalty period, but the amount not disclaimed can be used to cover nursing home expenses (alternate form of “rule of halves”)

B. Credit Shelter Trusts

The credit shelter plan carves out the amount of the client’s available applicable exclusion amount and bequeaths it to a trust for the benefit of the surviving spouse and children. The trust can be structured in a variety of ways, the most flexible of which permits discretionary distribution of interest and principal among surviving spouse and children, and at the death of the surviving spouse, passes to the surviving issue. At the death of the first spouse, no estate tax is due because a portion of the estate is protected by the applicable credit and presumably the balance is protected by the marital deduction. At the death of the surviving spouse, the credit shelter trust is not includible in her estate and the surviving spouse’s available applicable credit amount protects as much as possible of the surviving spouse’s assets. Thus, the children receive the benefit of both spouse’s applicable credits.

1. Capping the Credit Shelter Trust. 

· For couples with mid-size estates, it would be prudent to make the default credit shelter formula one which caps the amount passing to the credit shelter trust to avoid automatic payment of state estate tax, e.g. that amount which can pass free of federal and state estate tax by reason of the applicable exclusion amount, taking into account adjusted taxable gifts, other bequests under the Will, etc.

· Drafting a cap on the amount passing to the credit shelter trust:

i. Formula:

» ex.: an amount equal to the amount that can pass free of state estate tax

» ex.: an amount equal to the lesser of New York State exemption amount or a particular dollar amount

» ex.: an amount equal to the New York State exemption amount at the time of decedent’s death but in no event to exceed $_______ (or in no event to exceed ______ % of the value of the estate as finally determined for federal estate tax purposes)

ii. Specific dollar amount

iii. Fractional share

2. Problems with Use of a Credit Shelter Trust in Medicaid Planning.

· Assets passing to in trust to a surviving spouse, do not satisfy the spousal Right of Election under New York law.

The Right of Election. Under New York Estates, Powers and Trusts Law § 5-1.1-A, the surviving spouse of a New York decedent (who died on or after September 1, 1992) has a statutory right of election pursuant to which she may elect to take a share of the decedent’s estate which is the pecuniary amount equal to the greater of (i) fifty thousand ($50,000) dollars or, if the capital value of the net estate is less than fifty thousand ($50,000) dollars, such capital value, or (ii) one third of the net estate. Where the decedent died prior to September 1, 1992, EPTL § 5-1.1(a)(1)(A) provides that the elective share of the surviving spouse is one third of the net estate if the decedent is survived by one or more issue, and in all other cases, one half of such net estate.

· Pursuant to 96 ADM 8, refusing to assert one’s right of election against an inheritance constitutes a transfer of assets for Medicaid eligibility purposes.

Definition of Assets under Medicaid law. Assets are defined as income or resources which the individual or individual’s spouse is entitled to but does not receive because of any action or inaction by the individual or individual’s spouse. 18 NYCRR § 360-4.4(d)(2)(i)(a)(1)

· The assets of a community spouse would be deemed available to a Medicaid recipient spouse from the date the election is made. If no election is made, the penalty period for a waiver of elective share rights is measured from the community spouse’s date of death.

3. Alternate Drafting for Medicaid Purposes

· Assets of a credit shelter trust may be deemed available, depending on provisions of the trust, if surviving spouse subsequently needs to apply for Medicaid.

· Provisions of Will can provide for alternate dispositions that can still benefit a surviving spouse, while providing protection from creditors. Example: If right of election made the will could provide that the remaining probate estate could pass to a supplemental needs trust for the benefit of the surviving spouse. 

Contact Me

If you think you may require the assistance of Lisa Newfield in any matter, email (lnewfield@mccarthyfingar.com) or phone her (914-385-1032) with any question you may have.