Florida Probate & Trust Litigation Blog : Florida Probate Litigation, Will Contest Lawyer & Attorney : Juan C. Antúnez : Serving Miami, Jacksonville, Tampa Saint Petersburg, Orlando, Fort Lauderdale

Anyone can tell you what the current state of the law is when it comes to the federal estate and gift tax rules (news flash: for the first time in over a decade they're permanent, click here). For those of us in the trenches, the more interesting question is "what's next?" 

If I had to bet on what the next "big thing" in the estate-tax world is going to be, I'd go with one of the five "structural reforms" proposed by the President in his 2013 budget (and explained/scored in this recently published Congressional Research Service report). None of the ideas covered in the CRS Report is new, which means they've all demonstrated staying power (usually a good predictor of future enactment). And all of the proposed fixes have the added political bonus of increasing tax revenues without raising tax rates or lowering the exemption amount.

Want to know the future? Read on . . . 

CRS Report:

[T]he current size of the exemption and the rate of tax have been set in permanent tax law, and there is not much indication of a reconsideration. There are, however, some more narrow proposals aimed at abuse that have been included in some other legislation and in the President’s budget proposals. These provisions are described below. All of the estimates of revenue gain are for FY2013-FY2022 and are obtained from the FY2013 budget proposals. Most of the provisions were also estimated by the Joint Committee on Taxation and this source is used in the discussion below except in one case. Note that estimated budget effects would be altered and presumably reduced by the recent estate tax legislation.

[1] Grantor Retained Annuity Trusts

A Grantor Retained Annuity Trust (GRAT) is a trust that allows the grantor to receive an annuity, with any remaining assets transferred to the trust recipient. The value of the gift is reduced by the value of the assets used to fund the annuity. If the assets in the trust appreciate substantially, then virtually all of the gift can be reduced by the value of the annuity, while still providing a substantial ultimate gift to the recipient. If the grantor dies during the annuity period, the remaining value of the annuity is included in the estate. This trust approach could be a method of transferring assets roughly tax free if the assets appreciate at a rate faster than the discount rate used to value the annuity. The grantor needs to survive over the period of the annuity. To assure the latter will be likely to occur, many of these trusts have very short annuity periods, as short as two years. The GRAT proposal contained in H.R. 4849 in the 111th Congress and in the President’s budget proposals would impose a minimum annuity term of 10 years, disallow any decline in the annuity, and require a non-zero remainder interest. The provision was estimated to raise $3.6 billion over 10 years.

[2] Minority Discounts

There are existing restrictions to keep estates from engaging in artificial actions designed to reduce the value of estates (such as freezes on assets). As discussed above, courts sometimes allow estates to reduce the fair-market value when assets are left in family partnerships in which no one has a majority control. These discounts have even been allowed when assets are in cash and readily marketable securities, and the setting up of these family partnerships has become an estate tax avoidance tool. A provision in the Administration’s proposal would disallow these discounts. The JCT did not estimate this provision because of the lack of specific detail, but the Administration’s estimate was $18.1 billion over 10 years.

[3] Consistent Valuation

Currently, there is no explicit rule preventing a low valuation of fair-market value for an estate and a high valuation of the asset for purposes of stepped up basis in the hands of the heir. A low value of an asset reduces the estate tax, but a high value (because it reduces the amount of gain) reduces the capital gains tax. Requiring the same value for both purposes was projected to raise $3 billion over 10 years.

[4] Limit the Duration of Generation-Skipping Trusts

When generation-skipping transfers are made to a trust, the estate tax exemption applicable to them also exempts the associated earnings during the trust lifetime. In the past, a trust life has been limited because most states had a Rule Against Perpetuities that generally limited trusts to a 21-year life. Most of these laws have been eliminated. This Administration proposal would limit the life of a GST trust to 90 years. The revenue effect would be negligible over the next 10 years.

[5] Coordinate Grantor Trusts Income and Transfer Tax Rules

In a grantor trust, an individual is treated as owner for income tax purposes. However, the trust and the individual are treated as separate persons for purposes of the estate and gift tax. This proposal from the Administration would include the assets of the trust in the grantors estate and subject distributions to the gift tax if the grantor is the owner for income tax purposes. If the grantor ceases to be the owner, the assets would be subject to a gift tax. This proposal was projected to raise $3.3 billion over 10 years.

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For the first time in over a decade we have permanent federal estate and gift tax rules.

For those of us who didn't make it to the Heckerling conference in Orlando this year (including me, I usually go every other year), you'll want a quick and easy way to explain what the heck happened to the estate and gift tax after the fiscal cliff deal. There's no shortage of folks willing to give you their two cents on the subject, but separating the wheat from the chaff can be challenging.

So I was happy to run across an article by Forbes staff writer Deborah L. Jacobs entitled After The Fiscal Cliff Deal: Estate And Gift Tax Explained. Ms. Jacobs does a good job of explaining the new law in the type of plain English, question-and-answer format, clients like to hear; but she's also thorough enough to keep an audience of lawyers and CPA's interested. Good stuff, highly recommend it. Here's an excerpt.

Who has to pay federal estate tax? Once you’re worth more than a certain amount, taxes shrink your estate. Under the 2010 tax law, we can each transfer up to $5 million tax-free during life or at death. That figure is called the basic exclusion amount, and it is adjusted for inflation. In 2012 it was raised to $5.12 million per person. The new tax law does not change how much you can pass tax-free. On Jan. 11 the IRS announced that, with the inflation adjustment, the estate tax exclusion amount for deaths in 2013 would be $5.25 million.

Do spouses have to pay the tax when they inherit from each other? The new law doesn’t change this either. There is an unlimited deduction from estate and gift tax that postpones the tax on assets inherited from each other until the second spouse dies. This marital deduction, as it is called, applies only if the inheriting spouse is a U.S. citizen.

How much can the second spouse pass tax-free? Here’s where things get a bit complicated — but in a good way. The 2010 tax law gave married couples a wonderful tax break, which the new law has made permanent. Widows and widowers can add any unused exclusion of the spouse who died most recently to their own. This enables them together to transfer up to $10.5 million tax-free. Tax geeks call this portability.

. . .

How does this relate to lifetime gifts? The lifetime gift tax exclusion and the estate tax exclusion are expressed as a total amount – currently $5.25 million per person – and it is possible to use this exclusion (sometimes called the “unified credit”) to transfer assets at either stage or a combination of the two. If you exceed the limit, you (or your heirs) will owe tax of up to 40%.

. . .

Are there lifetime gifts that don’t count? Absolutely, and this is a common source of confusion. We can each give another person $14,000 per year without it counting against the lifetime exemption. (The amount went up at the end of 2012, as I reported here.) Spouses can combine this annual exclusion to double the size of the gift. Don’t confuse it with the basic exclusion–that $5.25 million discussed above.

Added Bonus:

For those of you who live for tax stat's, you'll want to read this recently published Congressional Research Service summing up the economics of the current state of affairs as follows:

Compared with the $1 million exemption and 55% rate under pre-EGTRRA law, the new rules lose an average of about $37 billion over the next 10 years, a two-thirds reduction in estate tax revenues. Regardless of the exemption levels considered, few estates are affected by the tax. The estate tax is a highly progressive tax, with about three-fourths collected from estates in which decedents are in the top 1% of the income distribution. At a $5 million exemption, less than 0.2% of estates will be subject to the tax. Although concerns have been raised about the effects of the tax on small businesses and farmers, estimates indicate that only a small share of these decedents would be affected.

. . . . .

Only a small portion of high-income decedents would be affected by the tax under the $5 million exemption.

• The estate tax will affect less than 0.2% of decedents over the next decade.

• The estate tax is concentrated among high income taxpayers: 96% is paid by the top quintile, 93% by the top 5%, 72% by the top 1%, and 42% by the top 0.1%.

• About 0.2% of estates with half or more of their assets in businesses will be subject to the estate tax.

• About 65 farm estates (or approximately one per state) are projected to be subject to the estate tax, and constitute 1.8% of taxable estates. Less than a fourth (0.4%) is projected to have inadequate liquidity to pay estate taxes. Less than 1% (0.8%) of farm operator estates is projected to pay the tax.

• About 94 estates (about two per state) with half their assets in small business and who expect their heirs to continue in the business are projected to be subject to the estate tax; they constitute 2.5% of total estates. Less than a half (1.1%) is projected to have inadequate liquidity to pay estate taxes.

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Estate of Bates v. Comm'r, T.C. Memo. 2012-314, 2012 WL 5445778 (U.S.Tax Ct. Nov. 7, 2012)

While we know what the federal estate tax rules are until the end of 2012, what happens in 2013 and beyond is anyone's guess. Under current law the estate tax exemption is scheduled to drop significantly from $5,120,000 in 2012 to $1,000,000 in 2013, and the top estate tax rate is scheduled to jump from 35% to 55%.

At a top rate of 55%, the federal estate tax automatically makes the IRS the single largest creditor for most large estates. That's the bad news. Here's the good news: as I've previously explained here and here, with a reasonable amount of sensitivity to the tax issues looming in the background of every taxable estate, litigation can often be shaped to create win-win opportunities by mining the tax code for "free money" to settle cases.

Consider the economics of the settlement agreement reached in the Tax Court case linked-to above. In this case the estate settled a will/trust contest by paying the challenger approximately $500,000 to drop his claims. The decedent in this case died in 2005, when the top estate tax rate was 47%. If the $500,000 settlement is a tax deductible expense, the heirs get a 47% deduction = to $235,000. Bottom line, if done right a $500,000 settlement payment "costs" the heirs only $265,000 after taxes. This is the kind of math that gets deals done and makes probate litigators look like geniuses . . . or not.

When the estate filed its estate tax return, instead of characterizing the $500,000 settlement payment as a validly deductible creditor claim under IRC § 2053, the exact opposite was done. The payment was characterized as a NON-deductible payment to an estate beneficiary as follows:

FUNDS PAID TO REGGIE LOPEZ IN EXCESS OF BEQUEST BY DECEDENT IN SETTLEMENT OF TRUST CONTEST LAWSUIT TO SETTLE TITLE TO BENEFICIARIES

As explained by the Tax Court, there's no way this kind of payment was ever going to fly as an estate tax deduction.

The estate contends that the settlement payment to Mr. Lopez is deductible. Pursuant to section 2053(a)(3), a claim against an estate is deductible if it is supported by adequate consideration and not attributable to the testator's testamentary intent. See sec.2053(c)(1)(A); Estate of Huntington v. Commissioner, 100 T.C. 313, 316, 1993 WL 99962 (1993), aff'd, 16 F.3d 462 (1st Cir.1994); Estate of Lazar v. Commissioner, 58 T.C. 543, 553, 1972 WL 2476 (1972); Estate of Pollard v. Commissioner, 52 T.C. 741, 745, 1969 WL 1656 (1969). The settlement payment to Mr. Lopez is not deductible because the payment lacked adequate consideration and was consistent with decedent's testamentary intent. See sec.2053(c)(1)(A); Estate of Huntington v. Commissioner, 100 T.C. at 316; Estate of Lazar v. Commissioner, 58 T.C. at 553; Estate of Pollard v. Commissioner, 52 T.C. at 745.

In support of his determination, respondent cites Estate of Huntington and Estate of Lazar, where the Court concluded that settlement payments to beneficiaries were not deductible. The estate contends that these cases are distinguishable because the settlement payments were paid to family members. While the settlement payments in these cases were to family members, the Court's reasoning is equally applicable to cases involving nonfamily members. Decedent had a longstanding and extremely close relationship with Mr. Lopez, expressly provided that he would receive estate assets, and memorialized her testamentary intent in both the First Trust and the Second Trust. In addition, the superior court resolved the amount of estate assets that Mr. Lopez was entitled to receive, and the settlement payment was paid in full satisfaction of any claim relating to the First Trust or the Second Trust. Furthermore, on the estate tax return, the estate reported that Mr. Lopez was a beneficiary and the settlement payment was paid to settle title to beneficiaries. During decedent's lifetime Mr. Lopez was paid for the services he rendered, and no part of the settlement payment related to a claim for unpaid services. In short, Mr. Lopez's claim represented a beneficiary's claim to a distributive share of the estate rather than a creditor's claim against the estate. See Estate of Lazar v. Commissioner, 58 T.C. at 552. 

Lesson learned?

If you're dealing with a taxable estate, it’s imperative that every decision made by the parties and their lawyers with respect to how they characterize and prosecute their trust/probate claims is considered against this backdrop. Whether a dispute is resolved through litigation or settlement, the nature of the underlying action determines the proper tax consequences. The taxability of a settlement is controlled by the nature of the litigation. The nature of the litigation is in turn controlled by the origin and character of the claim that gave rise to the litigation. And it’s the parties – not the IRS – that ultimately control this initial link in the causal chain.

Is it possible to frame the same set of facts as either a creditor claim against the estate or a will contest? If the answer is yes, one type of case is tax deductible (creditor claim), the other isn't (will contest). Did the contestant's lawyer only prosecute the challenger's individual interests or did this lawyer help the estate properly administer the estate for everyone's benefit? If it's the former, no tax deduction; if it's the latter, challenger's legal fees may be tax deductible (think more free money to settle). Get these questions right, everyone wins. Get them wrong . . . not so good.

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The competitive pressures and technical complexities of a sophisticated estate planning practice can be daunting. Not surprisingly, estate planning is one of the most common areas for legal malpractice claims. 

For me, what really matters is not whether you've ever made a mistake (no one's perfect), it's what you do after you realize you've made a mistake that really counts. While we've all learned that the cover-up is usually worse than the crime, if we're not careful, very human frailties can overcome ethics, one lie can lead to another, and before you know it a bad - but manageable - situation has morphed into a career-ending catastrophe. 

That's the bitter lesson Suzanne P. Land, a successful estate planning attorney, first female capital partner of her large Cincinnati, OH law firm, active community volunteer and single-mother of two young children (click here, and scroll down), is learning.

Back Story:

Land did estate planning work for a wealthy couple involving the creation of family limited liability companies ("LLC's"). The LLC's were supposed to lower the family's estate tax bill by creating valuation discounts. Although this kind of estate tax planning is fairly common, it's not without its complexities and hidden traps [click here for a sample memo explaining how it's all supposed to work]. One of those traps caught Land unawares; causing the LLC's to fail from a tax planning perspective. This mistake will likely cost Land's clients an extra $1.1 million in estate taxes.

When Land's mistake came to light during an estate-tax audit, rather than admit her mistake and deal with it head on, she tried to cover it up. The cover up included:

• Forging client signatures to create false, back-dated amendments to the LLC operating agreements
• Lying to the IRS about the forged LLC documents
• Creating fake client correspondence and legal invoices to reflect work she never performed, then providing these fake documents to the IRS to authenticate the forged LLC documents
• Providing two false affidavits to the IRS to authenticate the forged LLC documents

Cover Up = Criminal Prosecution:

No one should make light of how scary and professionally embarrassing a potential $1+ million malpractice claim must have appeared to Land. But no matter how bad the malpractice claim may end up being, it's nothing compared to the career-ending catastrophe the cover up lead to. After the cover up unraveled, Land eventually pled guilty to one count of tax obstruction (26 USC § 7212(a)). This type of felony can result in up to a three year prison sentence.

A DOJ press release described Land's conduct as follows:

According to the [unsealed portion of her plea agreement] and statements made in court, to conceal from the IRS the deficiencies in the documents that she drafted for her wealthy clients, Land forged the posthumous signatures of both her deceased clients and their living children on amendments to the documents. Land also misled an appraiser as to the value of the estates, created fake legal invoices that reflected work she never performed, and lied to the IRS about the circumstances surrounding the creation of the amendments. According to the terms of the plea agreement, Land admitted that the "relevant and foreseeable" tax loss that could have resulted from her obstruction was approximately $1,140,636.

According to the felony conviction/final judgment, Land was sentenced to 5 years of probation, including 3 years of what amounts to house arrest. It could have been much worse; at least she's not going to jail (unlike the Texas attorney I wrote about here, who was sentenced to two years in federal prison for intentionally falsifying an estate tax return).

At the time she pled guilty the local NBC affiliate reported here that Land's defense attorney stated she had voluntarily ceased practicing law and was "looking forward to getting this process through to the end." I'm not sure how "voluntary" this last step was. Land's felony conviction resulted in the automatic suspension of her law license in Ohio and Kentucky, effectively ending her legal career for the foreseeable future.

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United States v. MacIntyre, ___ F.Supp.2d ___, 2012 WL 2403491 (S.D. Tex. June 25, 2012)

A personal representative ("PR") is personally liable for paying the decedent's remaining tax bills, be they income taxes, gift taxes or estate taxes. That's right, when you say "yes" to serving as someone's PR, you also say "yes" to personally guaranteeing their back taxes are paid up. Not to worry though, as I previously wrote here, if you take advantage of the risk-management tools built into the tax code, this is a problem no one need lose sleep over. But get this wrong, and things can turn ugly real fast.

Is the IRS bound by your bad legal advice? NO

In 1995, J. Howard Marshall, II made a $35 million taxable gift to certain family members, including his ex-wife Eleanor Pierce Stevens ("Stevens"). For better or worse, Marshall Sr is probably best known for having been married to Anna Nicole Smith during the last 14 months of his life. If you're a trusts and estates lawyer, you can thank the Marshall estate and Anna Nicole Smith for some of the most high profile probate litigation in years [click here, here]. The Marshall name is shaking up the probate world again: this time around it's fiduciary liability for a decedent's unpaid taxes.

Marshall Sr never paid the tax due on his $35 million gift, and neither did his estate. By operation of law liability for Marshall Sr's tax liability shifted to the gift's recipients or "donees," including Stevens [click here for the back story]. Stevens died in April 2007, shifting her tax liability to her estate. E. Pierce Marshall, Jr. (“Marshall Jr”) became the sole executor of her estate and Finley L. Hilliard (“Hilliard”) was the trustee of her revocable trust. By its terms, Stevens' revocable trust was liable for her estate's taxes.

So what went wrong?

At some point Marshall Jr and Hilliard were told by their lawyers the IRS couldn't collect on the estate's unpaid gift-tax liability, so they went ahead and distributed estate assets without paying the tax. When the IRS came after them personally for the estate's unpaid taxes, they claimed ignorance. Not because they didn't know the gift-tax liability existed, but because they relied on their lawyer's bad tax advice. Wrong answer. Legal opinions are great ways to shift risk to your lawyers, but that's all you're doing. Tax opinions aren't shields against tax claims; the IRS isn't bound by your bad legal advice.

The Tax Court has articulated the elements of § 3713 liability as (1) a fiduciary; (2) distributed the estate's assets before paying a claim of the United State and (3) knew or should have known of the United States' claim. Huddleston v. Comm'r, T.C. Memo.1994–131, 1994 WL 100520 at *6 (U.S. Tax Ct.1994); see also Leigh v. Comm'r, 72 T.C. 1105, 1110 (U.S. Tax Ct.1979). “[I]n order to render a fiduciary personally liable under 31 U.S.C. [§ 3713], he must first be chargeable with knowledge or notice of the debt due to the United States....” Leigh, 72 T.C. at 1109 (construing a virtually identical earlier version of the statute). “The knowledge requirement ... may be satisfied by either actual knowledge of the liability or notice of such facts as would put a reasonably prudent person on inquiry as to the existence of the unpaid claim of the United States.” Id. at 1110.

**********

As explained above, the knowledge requirement is not actual knowledge. Leigh, 72 T.C. at 1110. It is sufficient to show that the fiduciary had “notice of such facts as would put a reasonably prudent person on inquiry as to the existence of the unpaid claim.” Id. Neither Marshall nor Hilliard contend that they were never told that the IRS might try to make a claim against Stevens for the unpaid gift taxes on the Gift. In fact, they admit that they were both told that the IRS might try to assert a claim against Stevens's Estate for donee liability on the Gift. Instead they argue that they did not believe the IRS's claim against Stevens was valid for various reasons. But, as the government points out, Marshall and Hilliard's belief in the validity of the government's claim is not the test. Marshall and Hilliard had sufficient notice of the claim to put a reasonably prudent person on notice. It is regrettable that they received incorrect advice on that point, but poor legal advice is not a defense. Despite their belief that the government's claim was not valid, Marshall and Hilliard were required by § 3713 to preserve the funds to pay the government's claim-should it be proved valid. Accordingly, Marshall and Hilliard both meet the test for individual liability under § 3713 and are therefore personally liable for distributions made from Stevens's Estate and Trust.

Is failing to pay taxes a breach of fiduciary duty? YES 

This probably comes as a surprise to most PR's, but a decedent's unpaid creditors, including the IRS, have standing to sue you for breach of fiduciary duty if you screw up. And not paying taxes qualifies as a major screw up. So to make matters worse, if you muck up an estate's taxes, not only are you personally on the hook for this mess, you may also get sued for breach of fiduciary duty. That's what happened in this case.

The government argues that Marshall, as Executor of Stevens Estate, breached his fiduciary duty to pay the taxes due the IRS on the estate in the order and manner they were due. In effect, it urges that Marshall's breach is coterminous with his personal liability under § 3713. The court agrees. Insofar as the court held above that Marshall was individually liable to the government pursuant to § 3713, he has also breached his fiduciary duty as an Executor under state law. See In re Tomlin, 266 B.R. 350, 354 (N.D.Tex.2001).

The question is, why would the IRS go through the trouble of suing you for breach of fiduciary duty if you're already personally liable as a matter of federal tax law? Answer: to make sure you don't dodge this bullet by declaring bankruptcy. As I previously wrote here, here, a breach-of-duty judgment against a PR (or trustee) is NOT dischargeable in bankruptcy. Why? Because under bankruptcy code section 523(a)(4) this kind of judgment is deemed the product of “fraud or defalcation while acting in a fiduciary capacity.”

Lesson learned? Forewarned is forearmed:

The best way to win a tax case is to not get sued by the IRS in the first place. You can't do that with a legal opinion. You can do that by making the IRS tell you in advance if there are any unpaid taxes. How do you do that? Click here. Forewarned is forearmed.

“The truly wise man, we are told, can perceive things before they come to pass; how much more than those that are already manifest.”

Sun Tzu, The Art of War

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Steve Akers of Bessemer Trust is one of the best speakers you'll ever have the pleasure of running into as a trusts and estates lawyer. As a former private practice T&E lawyer himself, he knows what's important for those of us in the trenches. Which is why I was especially interested in his recent write up of Rev. Proc. 2011-48 (the new IRS guidance for preserving § 2053 estate tax deductions that are uncertain and have yet to be paid) poetically entitled Protective Claim for Refund Procedures for Section 2053 Claims.

If an estate is both subject to the estate tax and litigation, a key issue everyone needs to stay focused on from day one is ensuring all applicable tax deductions under IRC § 2053 are preserved. For example, IRC § 2053 tax deductions include attorney's fees and costs (usually a big sticking point in T&E litigation). Maximizing IRC § 2053 tax deductions creates win-win opportunities by mining the tax code for new funds with which to settle disputes.

. . . . .

Summary of Procedures Under Rev. Proc. 2011-48

1. Time Period For Filing Protective Claim. The protective claim for refund may be filed at any time within the period of limitations for filing a claim for refund under §6511(a) (i.e., the later of three years after the return was filed or two years after the payment of tax). Rev. Proc. 2011-48, § 4.01.

. . . . .

5. Identification of the Claim or Expense; Ancillary Expenses. Each claim or expense for which a protective claim for refund is made must be clearly identified with “an explanation of the reasons and contingencies delaying the actual payment to be made in satisfaction of the claim or expense.” Rev. Proc. 2011-48, § 4.05(1). For contested matters, the protective claim must identify the contested matter and potential liability by including the name of the claimant, the basis of the claim, “the extent or amount of the liability claimed,” and a brief statement of the status of the contested matter. (A copy of relevant court pleadings generally will be sufficient to identify the claim.) Rev. Proc. 2011-48, § 4.04(3).

There is no necessity that the protective claim “state a particular dollar amount.” The 2009 § 2053 regulation confirms that even though the “specific dollar amount” issue is not addressed in the Revenue Procedure. Treas. Reg. § 20.2053-1(d)(5). This is a very important consideration in crafting the protective claim because a request for a specific high dollar amount of deduction would likely be a “smoking gun” in the underlying litigation about the contingent claim.

Ancillary expenses (such as attorneys’ fees, court costs, appraisal fees, and accounting fees) “related to resolving, defending, or satisfying the identified claim or expense” are automatically included as part of the claim for refund without the need for separate identification of these ancillary expenses. Rev. Proc. 2011-48, § 4.04(2).

CCA 200848045, provides a general overview of protective claims. While Rev. Proc. 2011-48 does not specifically refer to this Chief Council Advice, it may nevertheless assist in understanding the type of information that the IRS is seeking in identifying claims. CCA 200848045 says that Reg. § 301.6402-2 does not require that a particular dollar amount be asserted but the claim must “identify and describe the contingencies affecting the claim.” This requirement “is interpreted liberally by the Service. So long as the claim is sufficiently clear and definite [to] apprise us of the essential nature of the claim, it will be accepted as having met the requirement.” (This is important because providing too much detail about what makes the claim contingent may give the other side in the litigation insight into the taxpayer’s perceived weaknesses in its case.)

. . . . .

10. Limited Scope of Review. Rev. Proc. 2011-48 confirms that “generally the Service will limit its review of the Form 706 to the deduction under section 2053 that was the subject of the protective claim.” Rev. Proc. 2011-48, § 5.01, referencing Notice 2009-84. However, very importantly, the limited review described in Notice 2009-84 and in § 5.01 does not apply to “[a] taxpayer that chooses not to follow or fails to comply with the procedures set forth in this revenue procedure.” Rev. Proc. 2011-48, § 3.

The explicit reference to Notice 2009-84 is important, because that Notice provides insight into why the IRS inserted the word “generally” in the sentence about limiting the scope of review. The Supreme Court has held that the IRS can examine each item on a return to offset the amount a refund claim, even after the period of limitations on assessment has run. Lewis v. Reynolds, 284 U.S. 281, 283 (1932). However, the IRS in Notice 2009-84 agreed that it would limit the review of protective claims for refund to preserve the ability to claim a deduction under §2053 “to the evidence relating to the deduction under section 2053,” and not exercise its authority to examine each item on the return to offset a refund claim. This limitation does not apply if the IRS is considering a claim for refund not based on a protective claim regarding a deduction under §2053 in the same estate. Also, the Notice says the limitation applies “only if the protective claim for refund ripens after the expiration of the period of limitations on assessment and does not apply if there is evidence of fraud, malfeasance, collusion, concealment, or misrepresentation of a material fact.” The Revenue Procedure is not as explicit but makes a passing reference to this requirement about the refund ripening after the period of limitations has run. It says the limited scope of review applies when determining “whether there is an overpayment of tax based on a timely-filed section 2053 protective claim for refund that becomes ready for consideration after the expiration of the period of limitation on assessment ...” (Accordingly, there may be an advantage in not having resolved the underlying lawsuit regarding the claim against the estate until after the period on additional assessments has run — to the extent that there may be items on other parts of the estate tax return that the IRS might question if it could.)

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On December 17, 2010, President Obama signed H.R. 4853, the Middle Class Tax Relief Act of 2010, into law. This legislation extends the Bush-era Tax Cuts and it brings back the federal estate tax for two years at tax rate of 35% and with an exemption of $5 million.  It makes a number of other dramatic changes to wealth transfer taxes. Hani Sarji, author of Estate of Confusion, has created two excellent charts summarize these changes. For those of you looking for a quick reference source, these charts are worth holding on to.

In this blog post Mr. Sarji provides the following chart comparing the Estate, Gift and GST Tax rules in 2010 with those applicable in 2011.

In this blog post Mr. Sarji provides the following chart comparing the gift tax rules for 2010 with the new gift tax rules applicable in 2011 and 2012.

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Congress shocked everyone by letting the estate tax lapse in 2010. What I've found most interesting about this state of affairs are the unintended consequences:

First, no estate tax in 2010 is great news for the super rich, like George Steinbrenner's heirs, but bad news for the moderately wealthy, people who have assets between $1.3 million and $3.5 million. For these families dying in 2010 likely means higher taxes. This is a federal tax issue only Congress can address.

Second, no estate tax in 2010 could lead to the unintended disinheritance of widows and widowers, which could in turn lead to expensive legal fights among family members. Potential inheritance litigation caused by Congressional inaction is a state-law issue that state legislators can step in and fix. And that's exactly what they've been doing.

Increased probate litigation threat: Florida's statutory fix: 733.1051 & 736.04114

As reported by Forbes in States Race To Clean Up Congress' Estate Tax Mess, state legislators have been busy passing legislation aimed at avoiding the unintended disinheritance of widows and widowers caused by the unforeseen lapse of the federal estate tax in 2010. Florida has now joined the club with passage of two new pieces of legislation: 733.1051 (governing wills), and 736.04114 (governing trusts). This White Paper does a good job of explaining the reasoning behind the new legislation.

Most states enacted simple one-size-fits-all statutes. The upside to this approach is that it's less expensive to implement. Here's how these statutes were described in the Forbes piece:

Most of the new emergency laws would set a default rule for interpreting wills and trusts while the federal estate tax is repealed, if the document itself doesn't spell one out. The rule: Any tax terms or formulas should be read as if the estate tax law of 2009 were still in effect. The proposed emergency laws also typically include a backstop provision allowing any potential beneficiary or executor to go to court, within a year from the date of death, if he or she doesn't think that this default is what the deceased really wanted.

The downside to the one-size-fits-all approach is that saving court costs is given priority over ensuring the testator's intent is followed. Maybe the testator knew exactly what would happen if he died in 2010 and intended that outcome? A one-size-fits all statute could essentially strip this testator of his testamentary freedom.

Florida didn't adopt a one-size-fits-all statute, opting instead for a more nuanced approach aimed at determining the testator's probable intent from all of the facts and circumstances. If your primary goal is effectuating testator intent, Florida's approach makes sense. But it comes at a cost: Florida's legislation makes it impossible to avoid the time and expense of a judicial construction proceeding. Here's how the Forbes piece described Florida's approach:

One renegade state--Florida--is proposing to send folks with ambiguous documents to court from the start to determine the deceased's intent, instead of assuming the deceased wanted to follow the estate tax law of 2009. The court could consider outside evidence, such as the estate attorney's testimony. The proposed law would allow estate assets to be used to pay for this proceeding and says that heirs might have to wait for distributions pending the outcome of the court's decision.

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United States v. Guyton, Jr., 2010 WL 1172428 (11th Cir. March 26, 2010)

In this case a father sold his McAlpin, Florida poultry farm in January of 2000 and died six months later. Before his death dad deposited the sales proceeds in a joint account held with his son "Blake." These joint account funds went directly to Blake after dad's death. In other words, none of this cash ever became a part of dad's probate estate. After dad's death another son, "Guyton", was appointed personal representative or PR of dad's probate estate.

As dad's PR, Guyton was responsible for reporting the farm sale on dad's "final" 1040 income tax return and paying the income tax triggered by that sale. Along with this responsibility comes personal liability: as dad's PR, Guyton was personally liable for dad's unpaid taxes. This is all text book tax law, which I've written about here from a risk-management viewpoint and is also summarized nicely in Beneficiary and Fiduciary Liability for Income, Gift and Estate Taxes by Lakewood Ranch, FL estate planning attorney Marc J. Soss.

So what went wrong?

Brother Guyton, who appeared before the court on a pro se basis (in other words, without a lawyer), just could not understand why he was responsible for paying taxes on non-probate funds that went directly to his brother Blake. Unfortunately for Guyton, the IRS didn't buy his "it's just not fair" argument. By the time this case got to the 11th Circuit, the unpaid taxes, penalties and interests Guyton was fighting totaled a little over $50,000.

Here's how the 11th Circuit summarized Guyton's tax argument:

Guyton argues that, because Guyton, Sr. deposited the proceeds from the sale of his farm into a joint bank account prior to his death, the beneficiary of that bank account, Blake Guyton, is liable for the tax on those proceeds as “income with respect to a decedent,” under 26 U.S.C. § 691.

Income in respect of a decedent (IRD) is the name given to all types of taxable income earned, but not received by the decedent by the time of his or her death. If the farm-sale proceeds were IRD, then Blake would be on the hook for these taxes. If the farm-sale proceeds were NOT IRD, then Guyton is on the hook for paying these taxes . . . irrespective of the fact that this cash never flowed through dad's probate estate. The 11th Circuit ruled the farm-sale proceeds were NOT IRD:

When a taxpayer dies during the tax year, his personal representative must file a Form 1040 for the tax year in which the taxpayer died. See 26 U.S.C. § 6012(b)(1). That “final” 1040 will contain all gross income realized by the decedent, but only for the period in which the decedent was alive: the tax year effectively ends on the date of the taxpayer's death. 26 U.S.C. §§ 441(b)(3), 443(a)(2); see also Treas. Reg. § 1.443-1(a)(2) (generally, “the return of a decedent is a return for the short period beginning with the first day of his last taxable year and ending with the date of his death”). Thus, any income realized by the taxpayer after the date of death is “income in respect to a decedent.” See 26 U.S.C. § 691(a), (b); I.R.S. Pub. 559 at 9, 15-16. Accordingly, § 691 is inapplicable for income realized prior to the decedent's death because such income is properly reported on the decedent's final Form 1040. 26 U.S.C. § 691(a), (b); I.R.S. Pub. 559 at 9; Treas. Reg. § § 1.691(a)-1(a), (b) (defining “income in respect to a decedent” as income “not properly includible in respect of the taxable period in which falls the date of his death”) (emphasis added).

Because Guyton, Sr., realized a gain from the sale of his farm prior to his death [and actually received the sales proceeds prior to his death], .  .  .  his estate must pay the tax. Blohm v. C.I.R., 994 F.2d 1542, 1549 (11th Cir.1993). Depositing the proceeds into a joint bank account did not relieve or transfer his obligation to pay taxes on that gain. Id. Thus, summary judgment was proper on this issue and we affirm.

Lesson learned?

Although unstated in the 11th Circuit's opinion, my guess is that Guyton got himself into trouble by distributing most of dad's estate assets to himself and his siblings prior to being absolutely sure all of the estate's tax debts were paid up. As I explained here, there's a lot you can do to limit a PR's personal tax-exposure risk. But the number one most important lesson all PR's need to know is this: never ever distribute estate assets to the heirs until you're absolutely sure you've paid all of the decedent's taxes. Forget that lesson and you'll find yourself in the same boat as the poor PR in this case.

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Here's something you don't see every day: an acknowledgment by a credible source usually not associated with the "liberal media" (Rupert Murdoch's the WSJ) reporting that repeal of the estate tax is not a free ride, there are consequences: taxes will be shifted from a wealthier segment of the U.S. population to a less wealthy segment of the U.S. population. As reported by the WSJ in Why No Estate Tax Could Be a Killer:

Congress shocked everyone by letting the estate tax lapse on Jan. 1.

Now, here is the real stunner: For many, the lapse actually will raise taxes.

Under last year's law, estates up to $3.5 million, or $7 million for married couples, were exempt from federal tax. This year that law has been replaced by a fiendishly complex levy raising taxes on the assets of those with little as $1.3 million. It will affect the heirs of at least 50,000 U.S. taxpayers who die this year, whereas the old law affected only about 15,000 estates a year, according to the Tax Policy Center.

"The new system is far worse for many people who have assets between $1.3 million and $3.5 million," says veteran estate lawyer Ronald Aucutt, of McGuire Woods.

The linked-to article does a good job of walking readers through a simple hypothetical demonstrating how differently this year's and last year's regimes treat the same asset held by two fictional widows: Ms. Bentley has total assets of $20 million, while Ms. Subaru's total is $2 million. Guess who is paying more taxes this year?

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As reported by Forbes in States Race To Clean Up Congress' Estate Tax Mess, several states - including Florida - aren't waiting around for Congress to get its act together on the estate tax front.

While Congress dilly dallies, the states are racing to come to the aid of families whose estate plans have been thrown into disarray by the Jan. 1 lapse of the federal estate tax. That lapse could, among other things, lead to the unintended disinheritance of spouses, which could in turn lead to expensive legal fights among family members and, ultimately, the impoverishment of some widows or widowers. It could also, ironically, force some families to pay extra state estate taxes.

Legislators in a handful of states, led by Virginia [click here], have already introduced legislation to try to head off such bad results. Virginia's House of Delegates passed its "emergency" bill unanimously Tuesday and the state's Senate is expected to take it up immediately [click here]. Similar bills are pending in Maryland, Nebraska, South Dakota, Tennessee and Washington. Other states, including Florida and New York, have somewhat different legislation pending.

By the way, Forbes has a very cool interactive map showing state-level estate tax laws for 2010 [click here].

Florida's Statutory Fix

At this year's Heckerling conference one of the giants of the Florida trusts and estates bar, Bruce Stone, reported on Florida's statutory fix (CS/HB 361) in an excellent presentation entitled The Clock Struck Midnight: Now What Do We Do?  You can track the status of CS/HB 361 here. Full text of the bill is here.  The following is the proposed trust-code provision as reported by Bruce:

The following is a draft as of noon Monday, January 18, 2010, of a statute to be proposed for adoption in Florida, addressing the uncertainties and potential liabilities of fiduciaries caused by repeal of the estate and generation-skipping transfer taxes. The proposed statute may be submitted to the Florida legislature for its regular session which convenes on March 2, 2010.

Section I - section 736.04114 shall be created as follows:

736.04114 Limited judicial construction of irrevocable trust with federal tax provisions.--

(1) Upon the application of a trustee or any qualified beneficiary of a trust, a court at any time may construe the terms of a trust that is not then revocable to define the respective shares or determine beneficiaries, in accordance with the intention of the settlor, if a transfer occurs during the applicable period and the trust contains a provision that:

(a) includes a formula devise referring to the "unified credit", "estate tax exemption," "applicable exemption amount," "applicable credit amount," "applicable exclusion amount," "generation-skipping transfer tax exemption," "GST exemption," "marital deduction," "maximum marital deduction," or "unlimited marital deduction;"

(b) measures a share of a trust based on the amount that can pass free of federal estate tax or the amount that can pass free of federal generation-skipping transfer tax;

(c) otherwise makes a devise referring to a charitable deduction, marital deduction, or a similar provision of federal estate tax or generation-skipping transfer tax law; or

(d) appears to be intended to reduce or minimize federal estate tax or generation skipping transfer tax.

(2) For the purpose of this section:

(a) "applicable period" means a period beginning January 1, 2010 and ending on the earlier of (i) December 31, 2010, or (ii) the date that an act becomes law that repeals or otherwise modifies or has the effect of repealing or modifying Section 901 of The Economic Growth and Tax Relief Reconciliation Act of2001.

(b) a "transfer occurs" when an interest takes effect in possession or enjoyment.

(3) In construing the trust, the court shall consider the terms and purposes of the trust, the facts and circumstances surrounding the creation of the trust, and the settlor's probable intent. In determining the settlor's probable intent, the court may consider evidence relevant to the settlor's intent even though the evidence contradicts an apparent plain meaning of the trust instrument.

(4) This section does not apply to a transfer that is specifically conditioned upon no federal estate or generation skipping transfer tax being imposed at the time of the transfer.

(5) Unless otherwise ordered by the court, during the applicable period and without court order, the trustee administering a trust containing one or more provisions described in subsection (1) may (a) delay or refrain from making any distribution, (b) incur and pay fees and costs reasonably necessary to determine its duties and obligations (including compliance with provisions of existing and reasonably anticipated future federal tax laws), and (c) establish and maintain reserves for the payment of these fees and costs and federal taxes. The trustee shall not be liable for its actions as provided in this subsection made or taken in good faith.

(6) The provisions of this section are in addition to, and not in derogation of rights under the Florida Trust Code or the common law to construe a trust.

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At a top current rate of 45%, the federal estate tax automatically makes the IRS the single largest creditor of most large estates. If the estate tax is looming in the background it's imperative that every decision made by the parties and their lawyers with respect to how they characterize and prosecute their trust/probate claims be considered against this backdrop. I recently presented a national NBI seminar on this very same topic [click here].

At long last probate litigators and their clients have clearer guidance from the IRS on exactly how to make sure they maximize the tax-deduction benefits of estate litigation. The IRS has issued final regulations under IRC § 2053 governing estate tax deductions for administration expenses and claims against estates. Click here for a link to the new reg’s, which became effective on October 20, 2009.

In its background summary for the new reg's [click here] the IRS explained its thinking for why they were needed:

The amount an estate may deduct for claims against the estate has been a highly litigious issue. See the Background in the notice of proposed rulemaking published in the Federal Register on April 23, 2007 (REG-143316-03, 2007-1 C.B. 1292 [72 FR 20080]). Unlike section 2031, section 2053(a) does not contain a specific directive to value a deductible claim at its value at the time of the decedent’s death. Section 2053 specifically contemplates expenses such as funeral and administration expenses, which are only determinable after the decedent’s death.

The lack of consistency in the case law has resulted in different estate tax treatment of estates that are similarly situated, depending only upon the jurisdiction in which the executor resides. The Treasury Department and the IRS believe that similarly-situated estates should be treated consistently by having section 2053(a)(3) construed and applied in the same way in all jurisdictions.

Accordingly, in an effort to further the goal of effective and fair administration of the tax laws, the Treasury Department and the IRS published proposed regulations in the Federal Register on April 23, 2007. In formulating the proposed rule, the Treasury Department and the IRS carefully considered: the statutory framework and legislative history of section 2053 and its predecessors; the existing regulatory provisions under section 2053, particularly those that are generally applicable to all amounts deductible under section 2053; the numerous judicial decisions involving an issue under section 2053(a)(3) and the analysis and conclusion in each; and, the practical consequences of various possible alternatives for determining the amount deductible under section 2053(a)(3).

To help us make sense of it all estate-tax gurus Steve R. Akers and Jonathan G. Blattmachr/Mitchell M. Gans published excellent materials pointing out opportunities and pitfalls built into the new reg's for practitioners and clients alike [click here, here].

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I've recently been lecturing on tax issues in play in probate and trust litigation [click here]. After giving this lecture a couple of times I noticed a pattern: the single tax question most probate lawyers were concerned with was how to limit a personal representative's personal tax-exposure risk, which is inherent to all probate administrations.

Here's the problem:

A personal representative ("PR") is personally liable for paying the decedent's remaining tax bills, be they income taxes, gift taxes or estate taxes. See 31 U.S.C. §3713(b) and IRS Manual 5.17.13.8 (10-16-2007). That's right, when you say "yes" to being someone's PR, you also say "yes" to personally guaranteeing the IRS that all of their taxes are paid up. But how can a PR make sure the decedent wasn't cheating on his or her taxes? And how can a PR make sure he's uncovered all those skeletons in the closet before distributing any assets of the estate to the heirs?

Solution:

There are three risk-management tools every probate lawyer needs to know about and incorporate into his or her practice:

• IRS Form 56,
• IRS Form 4810, and
• IRS Form 5495.

Even if you're working with a CPA who's supposed to be taking the lead on all the tax issues, you need to know these protective measures exist and ensure your PR gets the full benefit of them. Here's why.

IRS Form 56 [click here]

A Form 56 needs to be filed twice: when your PR first gets appoint to let the IRS know who your PR is and where to send all tax notices; and again when your PR finishes his job and is discharged. What you're doing here is making sure that any correspondence from the IRS having to do with the decedent's taxes gets to your PR right away; the last thing you want is your PR to get sued for failing to pay the decedent's back taxes because the deficiency notices went to the wrong address. Also, the instructions to Form 56 state that the filing of a Form 56 when your PR is discharged will “relieve [the PR] of any further duty or liability as a fiduciary.”

IRS Form 4810 [click here]

Not only do you want to make sure the IRS knows your PR exists and that this is the person they need to contact for all matters related to the decedent, you'll also want to "shake the bushes" to make sure there are no unpaid back taxes involving the decedent. You do this by filing a Form 4810 (Request for Prompt Assessment for Income and Gift Taxes). A cautious PR will wait for the IRS to respond to this assessment request prior to making any distributions to the estate's beneficiaries. You don't want all the cash to go out the door only to be surprised by some huge tax assessment that puts your PR in the uncomfortable position of having to ask heirs to give money back to pay back taxes.

IRS Form 5495 [click here]

At the same time your PR files a Form 4810, he'll also want to simultaneously (but separately) file a Form 5495 (Request for Discharge from Personal Liability for Decedent’s Income and Gift Taxes). This is another way to make sure your PR gets the heads up on any of the decedent's unpaid back taxes. If Form 5495 is properly filed, the IRS has nine months in which to notify the PR of any deficiency for the decedent’s applicable income or gift tax returns. If the PR pays the additional tax, or if no notice is received from the IRS within nine months from the date of filing Form 5495, the PR is then discharged from personal liability.

For an excellent in-depth explanation of all three of these forms and how they work together to minimize a PR's personal tax-exposure risk (as well as other helpful hints), you'll want to read Minimizing a Personal Representative’s Personal Liability to Pay Taxes, Part I & Part II, by Florida trusts and estates attorneys William C. Carroll and John “Randy” Randolph.

But what payments can you make while you're figuring out the tax issues?

If the PR distributes any portion of the estate to the beneficiaries before all of the federal taxes are paid, he or she could be held personally liable to the extent of the distribution.  Personal liability under 31 USC § 3713(b) is the "muscle" behind the federal priority under 31 USC § 3713(a).

One way to manage a PR's personal tax-liability risk is to not pay a cent to anyone until every conceivable tax issue is identified and taken care of. But we all know this isn't possible. In order to properly manage an estate there are certain payments that can't wait.  Primary examples include court costs, reasonable compensation for the PR and the PR's attorney, and expenses incurred to collect and preserve assets of the estate. Fortunately PR's don't have to guess which payments they can and can't make without exposing themselves to personal liability. If a PR follows F. S. §733.707, which lists the distribution priorities for in-solvent estates under Florida's Probate Code, he'll be alright. Why? Because the payment priorities under Florida law are, for the most part, consistent with the payment priorities under 31 USC § 3713(a), as construed by the IRS (see IRS Manual 5.17.13.6 (10-16-2007)).

The only discrepancy between Florida's and the IRS's list of priority payments has to do with the payment of a family allowance. Under F. S. §733.707, a family-allowance payment is considered a "Class 5" priority, below the U.S. Government "Class 3" priority, but the IRS considers a reasonable family allowance payment to have priority over its claims for payment of taxes (see IRS Manual 5.17.13.6 (10-16-2007)). In other words, the IRS approach is more lenient than Florida's Probate Code.

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Tax issues loom large in trusts & estates litigation, especially when the estate tax is in play. So on Monday, September 14, 2009, I'm teaching a 90-Minute National Teleconference entitled Tax Issues in Trust and Probate Litigation [click here for seminar materials].

In this seminar we'll examine how an awareness of the tax issues lurking in the background of almost every contested proceeding can be leveraged to maximum advantage for all concerned.  Click here to sign up.  I hope you can join me.

Bonus Materials:

The written materials for this seminar [click here] include a copy of the Mediation Settlement Agreement discussed in Private Letter Ruling 200844010, in which the IRS ruled that if you split a single "QTIP" marital trust into five separate sub-trusts and then terminate just one of those sub-trusts, IRC § 2519 is triggered only with respect to the terminated sub-trust [see also here for related commentary on this case/ terminating a marital trust that's been QTIP'd]. The significance of this state of the art sample settlement agreement is that it provides an excellent real-life example of how to elegantly navigate all the issues you need to both anticipate and deal with in any settlement agreement involving a termination of a marital trust that's been QTIP'd. This sample document alone is worth the price of admission.

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Boulis v. Blackburn, --- So.3d ----, 2009 WL 2382358 (Fla. 4th DCA Aug 05, 2009)

The decedent at the heart of this probate battle, Konstantinos "Gus" Boulis, was a Greek immigrant and self-made millionaire who had started as a dishwasher in Canada and ended up in Florida, where he built an empire of restaurants, hotels and cruise ships used for offshore casino gambling. His 2001 gangland-style murder was allegedly linked to the $147.5 million sale of his company, SunCruz Casinos, to a partnership including disgraced Republican über lobbyist Jack Abramoff.

Apparently Boulis wasn't very fond of his wife: he completely cut her out of his estate. Lucky for her Boulis died a Florida resident, so she was able to claim a 30% share of his estate under F.S. § 732.201. That's the good news. The bad news is that she may have to fork over close to half of her share in estate taxes.

The Elephant in the Room: Estate Tax Allocation:

In large estates the elephant in the room is always: "who's going to pay the estate tax?" Considering that the top marginal estate tax rate is 45%, whose share of the estate gets used to pay this tax bill is a huge big deal. For example, if Boulis's widow was awarded a $10 million elective share, how the estate-tax allocation question is answered could mean the difference between her walking away with $10 million or $6.5 million!

Usually zero estate taxes are allocated to a widow's elective share because of the unlimited estate-tax marital deduction. However, Boulis's widow wasn't a U.S. citizen, so the normal rules don't apply. But even for non-citizens, it's pretty easy to avoid paying any estate tax by creating a qualified domestic trust or "QDOT" to hold the widow's share of the estate. For reasons not explained by the 4th DCA, this hasn't happened in this case.

Having failed to dodge the estate-tax bullet by relying on the federal tax code provisions governing QDOTs, Boulis's widow fell back on two state-level statutory-construction arguments involving F.S. 733.817, Florida's estate-tax allocation statute.

[1]  Is an elective share ever liable for estate taxes?

Because elective-share assets going to a surviving spouse almost never trigger any estate tax, F.S. 733.817 doesn't have a specific clause addressing those rare instances where a tax is triggered. Boulis's widow argued this omission means taxes are NEVER allocated to elective share assets. Wrong answer says the 4th DCA, here's why:

Appellant argues that certain probate code sections relieve her elective share of any liability for estate taxes. Section 733.817, Florida Statutes (2000), governs the apportionment of estate taxes. Subsections (5)(a), (5)(b), and (5)(c) apply to the apportionment of taxes on property passing under the decedent's will, property passing under the terms of any trust created in the decedent's will and homestead property, respectively.

*     *     *

“The purpose of section 733.817 is to ensure that all estate and inheritance taxes are shared on a ratable basis by the beneficiaries receiving the property subject to those taxes.” Tarbox v. Palmer, 564 So.2d 1106, 1108 (Fla. 4th DCA 1990). As appellant is not entitled to the marital deduction on her elective share, then that elective share is subject to tax. The net tax on an elective share is not apportioned under paragraphs (5)(a), (5)(b), or (5)(c), and it is not otherwise excluded. Therefore, the net tax attributable to the elective share is apportionable under section 733.817(5)(f).

[2]  But what if the decedent waived the normal tax allocations rules?

Boulis's widow then argued that even if her share of the estate was taxable, her husband's will trumped application of the Florida tax allocation statute because it directed that the payment of taxes attributable to property NOT passing under his will (such as her elective share) must be paid from property passing under his will (read: tax everyone else but the widow). This allocation argument has a long and storied past here in Florida. Unfortunately for Boulis's widow, by now it's pretty well settled that the language in the will has to be extremely specific for this argument to work. In this case it wasn't, so she lost this argument as well.

In his will, the decedent “direct[s][his] Personal Representative to pay out of the property which would otherwise become a part of the Residuary Estate, all estate, inheritance, transfer and succession taxes, including interest and penalties thereon, which may be lawfully assessed by reason of my death.” Appellant argues that pursuant to section 733.817(5)(h)1., Florida Statutes (2000), this provision of the will directs appellees to pay the taxes on the elective share out of the residuary estate. The trial court held that section 733.817(5)(h)4., Florida Statutes, is the applicable provision and, under that section, the decedent has not effectively directed the payment of taxes attributable to property not passing under the governing instrument from property passing under the governing instrument.

Section 733.817(5)(h), Florida Statutes, provides in pertinent part:

(h)1. To be effective as a direction for payment of tax in a manner different from that provided in this section, the governing instrument must direct that the tax be paid from assets that pass pursuant to that governing instrument, except as provided in this section.

*     *     *

4. For a direction in a governing instrument to be effective to direct payment of taxes attributable to property not passing under the governing instrument from property passing under the governing instrument, the governing instrument must expressly refer to this section, or expressly indicate that the property passing under the governing instrument is to bear the burden of taxation for property not passing under the governing instrument. A direction in the governing instrument to the effect that all taxes are to be paid from property passing under the governing instrument whether attributable to property passing under the governing instrument or otherwise shall be effective to direct the payment from property passing under the governing instrument of taxes attributable to property not passing under the governing instrument.

In In re Estate of McClaran, 811 So.2d 799 (Fla. 2d DCA 2002), the Second District addressed the issue of whether the direction in the decedent's will was effective under section 733.817(5)(h) to override the statutory method of apportionment of estate taxes. McClaran's will provided in pertinent part:

My personal representative shall pay from the residue of my estate ... estate and inheritance taxes assessed by reason of my death, except that the amount, if any, by which the estate and inheritance taxes shall be increased as a result of the inclusion of property in which I may have a qualifying income interest for life or over which I may have a power of appointment shall be paid by the person holding or receiving that property.

Id. at 800 (emphasis in original).

*     *     *

Just as in McClaran, the direction in the decedent's will does not include an express indication that the property passing under the will is to bear the burden of taxation for property not passing under the will.

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U.S. v. Guyton, Slip Copy, 2009 WL 1308431 (M.D.Fla. May 08, 2009)

The IRS is the "über" creditor of any probate estate. Why? Two reasons. First, the personal representative (PR) is personally liable for any of the decedent's unpaid taxes to the extent the PR pays any debts due by the decedent before paying the decedent's tax liability. 31 U.S.C. § 3713(b); IRS Manual § 5.5.1. There's nothing like personal liability to focus the mind. Second, the normal rules simply don't apply to the IRS. As the court ruled in the linked-to order, the IRS is NOT subject to the limitations periods applicable to all other creditors:

Turning to Defendant's final threshold argument, case law makes clear that the Government's claim is not subject to state statutes of limitation, including Florida Statute § 733.705(8), absent its own consent. See e.g., United States v. Summerlin, 310 U.S. 414 (1940); see also United States v. Kellum, 523 F.2d 1284, 1286 (5th Cir.1975).

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Veteran Florida probate litigator Amy Beller was kind enough to direct me to Private Letter Ruling 200844010, in which the IRS ruled that if you split a single marital trust into five separate sub-trusts and then terminate just one of those sub-trusts, IRC § 2519 would be triggered only with respect to the terminated sub-trust. The significance of this PLR is that it provides an excellent summary of the transfer-tax consequences you need to both anticipate and deal with any time you terminate a marital trust that's been QTIP'd, while also explaining how to manage those tax issues by elegantly leveraging the flexibility built into Florida's new Trust Code.

Here's a key excerpt from the linked-to PLR:

In the present case, Spouse has a qualifying income interest for life in Marital Trust, and Child 1, Child 2, Child 3, Child 4, and Child 5 are the presumptive remainder beneficiaries. Pursuant to Settlement Agreement, Marital Trust will be divided into five trusts: specifically, four Surviving Settlement Trusts and Child 1’s Settlement Trust. Under State Statute 1, each of the five trusts will be treated as a separate trust for all purposes from the date on which the severance is effective. After the division, Spouse will have a qualifying income interest for life, and Child 2, Child 3, Child 4, and Child 5 will be the remaindermen of the Surviving Settlement Trusts. Child 1’s Settlement Trust will be terminated. Accordingly, based on the facts submitted and representations made, we conclude that the division of Marital Trust into five trusts and the subsequent termination of Child 1’s Settlement Trust pursuant to Settlement Agreement will not be deemed to be a transfer under § 2519 of any property interest, or interest in, the Surviving Settlement Trusts, and therefore, such division and termination will not give rise to any gift tax liability with respect to any property of, or interest in, any of the Surviving Settlement Trusts.  

Amy represented the surviving spouse/income beneficiary of the marital trust, so she deserves a good amount of the credit for this PLR.  By the way, South Florida tax lawyer Charles Rubin also wrote about this PLR here on his blog Rubin on Tax.

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