TAX TALK

REPORT FROM THE HECKERLING INSTITUTE
By Harold W. Pskowski

The Thirty-Seventh Heckerling Institute on Estate Planning opened on January 6 with a greeting from University of Miami President Donna Shalala. She observed that she has a close connection to our profession through her 90-year old mother, who is a still-practicing attorney in Cleveland, Ohio. President Shalala offered no excuses for the recent performance of her school’s football team, but promised that we would be exposed to the best minds in estate planning during the coming week.

That promise drew a record crowd of approximately 3,000 attorneys, CPAs, trust officers, and financial planners to the Institute. These numbers were surprising, given the increasingly likely demise of the estate tax, but the planners of the Institute had managed to skillfully weave a number of sessions devoted to non-tax issues into the usual discussions of transfer tax planning. This report focuses on the tax-related sessions that seemed of most interest to the practitioner.

The Institute proceedings opened with a discussion of estate, gift and income tax developments during 2002, led by Carlyn McCaffrey, Dan Hastings, and Howard Zaritsky. Two items stood out here. The first was the Service’s successful attack on family limited partnerships using Code §2036, coming after years of failure under Chapter 14. The speakers pointed out that the IRS has been successful with its §2036 approach when the founder and his family have been careless in observing the formalities of the partnership form. The panelists agreed that these decisions appear to be correctly decided, but pointed out that the §2036 argument can be avoided through the careful creation and operation of the partnership. Zaritsky, in particular, emphasized the importance of ensuring that the client properly operates the partnership on an ongoing basis, and suggested that this responsibility be delegated to the client’s accountant.

The second matter that stood out here was the reaction of the states to EGTRRA’s phase out of the state death tax credit and increase in the unified credit. By now, most readers are familiar with Maryland’s decoupling of its estate tax from the state death tax credit, but there have been a variety of responses in other states. Some states have acquiesced in the federal action, while others have taken steps to ensure that their revenues will not be reduced by EGTRRA. The lesson here is to familiarize yourself with the estate taxes in any states in which your clients have immovable property.

Jonathan Blattmachr next spoke about life insurance trusts, offering some of his usual cutting-edge ideas. He advocated the use of “cascading” Crummey powers in insurance trusts to avoid using GST exemption when grandchildren are potential beneficiaries. Under a “cascading” power, the initial Crummey withdrawal right over the premium payment is given to the grantor’s child. When the child fails to exercise the power, the trust gives a new withdrawal power over the same property to the grandchild. According to Blattmachr, the child, by reason of his failure to exercise his power, becomes the transferor of the property subject to the power, and any future distributions to the grandchild will not be subject to the generation-skipping tax.

Larry Katzenstein of St. Louis spoke on “Turning the Tables: When Do the IRS Actuarial Tables Not Apply?” He was critical of certain IRS regulations issued under §7520, particularly the trust exhaustion rule, which limits the value of an annuity if the fund would be exhausted before the annuitant reached age 110. This rule can be applied to both GRATs and charitable lead annuities. Katzenstein feels that the regulation misunderstands the nature of exhaustion and can lead to absurd results. He also criticized the recent Shackleford decision in the Ninth Circuit, which held that the valuation of lottery winnings in a decedent’s estate was not controlled by §7520 because of the non-assignability of the payments. Katzenstein pointed out that most trusts have spendthrift clauses to prevent assignment, yet valuation of trust interests are clearly controlled by §7520. He conceded, however, that Shackleford could be useful precedent if you are trying to get out from under the tables.

Pam Schneider, Paul Frimmer, and Carol Harrington gave a presentation on “Drafting after EGTRRA.” Like most recent commentary on this subject, their suggestions for post-EGTRRA drafting can be broken down into three distinct approaches: (1) the use of complex formula clauses; (2) relying on the surviving spouse to disclaim into the credit shelter portion; and (3) allowing the executor to make a partial QTIP election, with the non-elected portion being diverted to a credit shelter trust (a so-called Clayton marital). They also suggested drafting language for carryover basis, should it ever become a permanent feature of the Code. Although the speakers offered some sound solutions to the drafting problems caused by EGTRRA, much of their drafting language seemed excessively complex and would be difficult to explain to many clients. 

William P. LaPiana of the New York Law School gave an interesting talk on the state response to EGTRRA. He pointed out that, unlike Maryland (which only decoupled itself from the phase out of the state death tax credit), a number of states have decoupled themselves from all the EGTRRA changes, including the increase in the unified credit. These states, which include the District of Columbia, Massachusetts, and New Jersey, will continue to impose their estate taxes to taxable estates using a pre-EGTRRA unified credit, meaning that their estate taxes will kick in at the $675,000 or $1.0 million level. In these states, he observed, the use of a formula credit shelter clause tied to the federal credit could result in significant, and perhaps unnecessary, state tax. His outline included a useful description of how each state will apply its tax after EGTRRA.

Richard B. Robinson, from Denver, Colorado, gave a valuable presentation on post-mortem planning with family limited partnerships, with an emphasis on how to remove the assets from partnership form with minimal tax impact. He pointed out that family members often want to unwind the partnership as soon as the founder is under ground, but cautioned that this option should not be broached until the estate tax closing letter is in hand. He emphasized the importance of knowing the partnership income tax rules, and pointed out the potential tax liabilities associated with sales or transfers of property that had built-in appreciation when contributed to the partnership. If you have any question about what to do with an FLP after the founder’s death, this is the article to go to. Daniel H. Markstein of Birmingham, Alabama, gave a related presentation on post mortem planning with FLPs, focusing on some of the non-tax issues, such as security laws restrictions that may apply to FLP interests.

John R. Price from Seattle, Washington, offered a good session on planning with GRATs. He advocated the use of “zeroed out” GRATs that the Tax Court approved of in Walton, with relatively short terms to lessen the mortality risk. He also had an interesting idea for using a private annuity within an intentionally defective grantor trust. He claims that this avoids both the mortality risk of a GRAT and the risk that property sold to the trust would be includible under §2036. The technique is too complex to describe here, so you should review his outline if you are able.

The Heckerling Institute offers a number of afternoon workshops, some focusing on topics addressed in the primary sessions, others on separate estate planning and tax issues. These are more informal than the morning lectures, and allow questions from the audience. One workshop that drew a large crowd was a session on transfer tax audit issues. The speakers were Mary Lou Edelstein and Martin E. Basson, both with the IRS, and two tax attorneys, John W. Porter from Houston and Norman J. Benford from Miami. The discussion quickly swung to valuation issues, particularly family limited partnerships

Edelstein explained that since April 1999 she has been the national family limited partnership coordinator at the Appeals level. The IRS is trying to maintain consistent results in FLP cases at Appeals, and any Appeals Officer is required to call her before offering an FLP settlement. She revealed that the Service is willing to settle FLP cases at significant discounts, provided that the FLP is not a “death bed” partnership (i.e., formed within six months of death) and that the partners have observed the partnership form to avoid the §2036 argument. She also cautioned that the IRS is not likely to offer a settlement in cases where the decedent placed all his assets in the partnership; the expectation is that sufficient assets were left outside the partnership to maintain a reasonable standard of living.

If the partnership can pass these hurdles, Edelstein indicated that Appeals may offer a 35% to 40% discount for partnerships holding a business or real estate, and a 25% to 30% discount for a partnership holding marketable securities or other passive assets. Given the size of the discounts now accepted by the IRS, it is this writer’s opinion that an advisor may be doing a disservice to his or her client by failing to recommend an FLP to the appropriate client. The speakers cautioned, however, that there is little coordination of FLP issues at the examination level, where the discounts are much less predictable. 

The panelists also discussed the “tax-effecting” of assets with a built-in tax liability. Edelstein and Basson confirmed that the IRS has conceded the validity of tax-effecting the value of a C corporation. The amount of the discount, they said, depends upon the amount of the built-in tax liability and the likelihood that the corporation will be liquidated. The IRS does not, however, allow tax-effecting for S corporations and partnerships, they said, and rejected out of hand any attempt to tax-effect the built-in tax liability in an IRA or other retirement plan, citing the recent TAM 200247001.

Other topics addressed in the primary sessions of the Institute were: (1) “What to Do with Art and Other Valuable Stuff,” Ralph E. Lerner; (2) “Charitable Lead Trusts Re-Examined: The Dawning of a Golden Age,” Edward J. Beckwith; (3) “Did They Get It Right? The Final Minimum Distribution Rules,” Louis A. Mezzullo; (4) “Worth the Effort Beyond the Grave—An Update of Post-Mortem Tax Planning Strategies,” Steven R. Akers; (5) “What Do You Mean Subpoena? I’m a Lawyer!” Russell Allen; (6) “The Durable Power of Attorney: Why You Should Give More Attention to Estate Planning’s Stepchild,” Karen Boxx; and (7) “Terrorism of Its Prospect—The Impact on Estate Planning,” Roy M. Adams. All of these came with well-prepared outlines, which will be available from LexisNexis when it publishes the annual proceedings.