The Year In Review, 2008

Plus: Estates In The News

Reprinted from The Estate Analyst, December 2008

By Robert L. Moshman, Esq.

hooosh! Another year has rushed by (except for the months when it dragged on, such as during an endless election, or when oil prices were heading toward $150 per barrel, or when staggering stock market losses left investors stunned, shocked, disturbed, and depressed or when a series of financial melt downs took place on such a grand scale).

Okay, the year didn't rush happily along; 2008 can't end fast enough!

But before closing the books on the year gone by, let's take a look back at the highlights and developments affecting financial planning.

The Supremes Talk Trusts

This is the time of year when we usually report that the Supreme Court hasn't trifled with the likes of fiduciaries, trusts and estates. Not this year!

In 2008 the Supreme Court took up three cases involving trusts and fiduciaries and the entire Court threw itself into carving out nuanced positions. Two pension fiduciary related cases will be covered in a future issue. Here, we review, Knight v. Commissioner, 128 S.Ct. 78, 502 U.S. ____ (2008), which arrived on January 16, 2008.

This tale began in 1967 when a testamentary trust arose from the will of Henry A. Rudkin whose family had sold the Pepperidge Farms company to the Campbell Soup Company in the 1960s. The proceeds of that sale funded the Henry A. Rudkin Testamentary Trust and later passed through the estate of his son and into the William L. Rudkin Testamentary Trust.

In 2000, the Trust had assets of $2.9 million. The trustee paid $22,241 for investment advice, reported income of $624,816 and deducted the advisory fees. The IRS found that the fees were only deductible to the extent they exceeded 2% of the Trust's adjusted gross income. Only $9,780 could be deducted. This resulted in a tax deficiency of $4,448.

Although the Supreme court sided with the Commissioner and lower courts in rejecting petitioner's claim for the $4,448, the unanimous opinion written by Chief Justice Roberts focused on the language of the IRS Code and took an unexpected detour. The standard for analysis is not whether the expenses could not have been incurred but for the investments being in trust (as the Second Circuit had concluded) but whether such expenses "would not" have been incurred.

Dawn Follows Knight

IRS regulations established after the Second Circuit opinion in Knight were designed to unbundle administrative fees to prevent a Trojan horse of fees that exceeded what "could have" been incurred.

By late February, the IRS issued interim guidance on the issue in Notice 2008-32 in which it announced that it expects to issue final regulations under § 1.67-4 of the Income Tax Regulations consistent with the Supreme Court's holding in Knight.

"The final regulations also will address the issue raised when a nongrantor trust or estate pays a Bundled Fiduciary Fee for costs incurred in-house by the fiduciary, some of which are subject to the 2-percent floor and some of which are fully deductible without regard to the 2-percent floor."

Notice 2008-32 then provides interim advice. Taxpayers will not be required to determine what portion of a "bundled fiduciary fee" is subject to the 2% floor under section 67 for any taxable year beginning before January 1, 2008.

Instead, for each such taxable year, taxpayers may deduct the full amount of the Bundled Fiduciary Fee without regard to the 2-percent floor. Payments that are made directly to third parties for expenses subject to the 2% floor, such as advisory fees considered in the Knight Supreme Court decision, that are readily identifiable as encompassed by that decision, must be treated separately from bundled fees, and are subject to the 2% non-deductible floor for tax returns currently being filed by fiduciaries.

Post Knight Jousting

The final regulations may contain one or more safe harbors for the allocation of fees and expenses between those costs that are subject to the two-percent floor and those that are not. Any safe harbors in the final regulations for determining the allocation of a bundled fiduciary fee between costs subject to the 2-percent floor and those not subject to the 2-percent floor may be available for taxpayers to use for taxable years beginning on or after January 1, 2008.

The IRS and the Treasury Department anticipate that final regulations under § 1.67-4 will be published without delay after the extended comment period granted in the Notice. But not everyone is accepting of the results of the IRS and Knight.

On May 27, ACTEC (American College of Trust and Estate Counsel with 2,600 members ), sent a 3,900 word comment about the proposed regulations on IRS section 67(e) but simply concluded that "we are not able to formulate a clear picture of the manner in which the IRS or Treasury intend to modify the Proposed Regulations, and cannot effectively respond to this invitation to comment * * *," and therefore suggested that the regulations be issued as temporary or proposed regulations.

In September, the AICPA (American Institute of Certified Public Accountants with 35,000 members), making an end run around the IRS, wrote a five-page letter to Congress in support of bipartisan legislation to amend section 67(e). "The measure would simplify the law and make it clear that executors and trustees may fully deduct costs incurred to administer their estates and trusts."

Florida Homesteads

In April, we reported that Florida's Supreme Court had ruled that a Florida resident cannot waive his or her homestead exemption without a secured agreement. The case involved a client who signed an attorney's retainer agreement for services related to an amendment of alimony and child support. The retainer agreement contained a clause waiving the homestead exemption. The trial court upheld the waiver clause and allowed a lien on the client's home, and the Court of Appeals reversed.

The homestead exemption has been a part of the Constitution of Florida for the past 123 years and prevents a forced sale of the homestead and limits liens to property taxes and home improvements. The homestead is limited to a home and one-half acre if within a municipality or a home, and 160 contiguous acres if outside a municipality. In 1884 and 1956, the Florida Supreme Court rejected unsecured waivers of the homestead exemption.

In, Chames v. DeMayo, 32 Fla. L. Weekly S820 (Fla. Dec. 20, 2007), the Court noted a modern trend toward allowing waivers of personal rights, but noted that few jurisdictions permit a general waiver of homestead in an executory contract and rejected an assertion of a national trend to allow such waivers. It then upheld prior case law because the homestead exemption is intended to protect not only the individual but also the individual's family as well as the State.

Thus, a Florida resident can mortgage a homestead directly but cannot waive the homestead merely by signing boilerplate language that is inserted into some other agreement for the extension of credit. A gift, sale, or mortgage of property would constitute a knowing, voluntary, and intelligent waiver of the exemption.

Another case of interest is, In re Lloyd 07-13502, which, as described in an article on the Florida Asset Protection Blog by Jonathan Alper, Esq., a Florida resident moved to California in 2003, declared bankruptcy in 2007 and still was able to claim the homestead exemption for the home she maintained and rented out in Florida.

New LLC Variations

In May we reported on one of the newest forms of business. A Series LLC allows each of the various entities in an individual's estate (or a family's estate) to be gathered up and administered in one entity for tax purposes, while retaining the separate status of each entity for liability purposes. The Series LLC involves a master LLC that files one income tax return despite having multiple "series" or "cells" consisting of separate LLCs or other entities. Debts, liabilities, and obligations of one Series are only enforceable against that Series. A Series can be added or deleted from a master LLC. The Series LLC originated in Delaware in 1996. Since 2005 there has been a flurry of interest and enabling legislation for Series LLCs has been enacted in Illinois, Iowa, Oklahoma, Nevada, Tennessee, and Utah. A streamlined version of the Series LLC was enacted by Wisconsin.

Caveats: This is a relatively new and untested technique. California has indicated that each Series of a Delaware Series LLC must report and pay taxes separately in California. There is some speculation that highly correlated assets, members, and managers may be required to justify single entity federal tax treatment.

In July we reviewed the L3C, i.e., a low-profit limited liability company. IRS regulations require most private foundations to give away 5% of net assets each year. Assets can be given to a for-profit entity which is a program related investment (PRI).

But demonstrating that a for-profit entity qualifies as a PRI requires a private letter ruling or a leap of faith. Filling the need for a reliable PRI, someone designed an LLC that makes profits and shareholder interests secondary to achieving social benefits. Because LLCs are accepted in all 50 states such an L3C entity could, conceivably, provide a reliable solution for private foundations in most if not all jurisdictions.

New Expatriation Rules

Under the new Heroes Earnings Assistance and Relief Act, there is a new approach to taxation of expatriates. Effective for citizens who expatriate after June 16, 2008, Section 877A now imposes an "exit tax" on "Covered Expatriates" who have a net worth in excess of $2 million or an average annual income tax liability in excess of $139,000 over the five years preceding expatriation.

Such expatriates will be deemed to have sold all their assets, with an exemption of $600,000. Covered Expatriates with an interest in non-grantor trusts will be subject to special 30% withholding and any direct or indirect gift or bequest to a U.S. person will be taxed at the highest applicable rate under new section 1208.

Estates In The News

The Helmsley Dog Trusts: When Leona Helmsley passed away at age 87 in 2007, headlines focused on a large bequest to a small dog. The real estate heiress, also known as "The Queen of Mean," had left funds for "Trouble" a five-pound Maltese. Other terms of Ms. Helmsley's will disinherited two of her grandchildren and other relatives were given bequests conditioned on their visiting her $1.4 million mausoleum and signing into a guest book. Mrs. Helmsley's will poured $12 million to a 2005 trust of which Trouble was the sole beneficiary. One year later, a New York Surrogate Court judge cut Trouble's trust to $2 million and gave $6 million settlements to the disinherited grandchildren. Trouble, herself, was bequeathed to Mrs. Helmsley's brother, who disclaimed the bequest. Trouble now lives with a caretaker in Florida. The caretaker is paid $60,000 annually for this task and $100,000 is spent annually for full time security.

Dannielynn is Sole Heir: Dannielynn, the daughter of Anna Nicole Smith, was declared the sole heir of her mother's estate. A Los Angeles judge established a trust for the child with her father Larry Birkhead and Smith's executor Howard K. Stern as co-trustees. A will executed prior to Dannielynn's birth purported to disinherit future children other than Daniel Smith, who died at age 20. The Smith estate continues to pursue a legal battle with the estate of billionaire J. Howard Marshall.

Widows In Court: Buddy Holly's widow went to court to stop Peggy Sue from selling a book about her friendship with Holly (who died in 1959). The widow of Sammy Davis, Jr. filed a legal action against two of her husband's former business partners for allegedly defrauding her into signing away rights to her husband's estate, which owed the IRS $5 million at his death. Hynie Brown, the purported fourth wife of James Brown has been battling a host of family members and others over the estate of the late singer while his children have challenged his will.

Magnificent Gesture: James Sorenson, who was born in poverty and became a self-made billionaire ranking 68th on the Forbes 400, left $4.5 billion to his charitable foundation.

Huh?: "Heirs" of the Knights Templar are suing Pope Benedict XVI in a Spanish court for $150 billion in assets seized by the church in 1307 and to restore their good name. Spanish newspapers say the issue is for psychiatrists not historians.

The von Bulow Estate

Alan Dershowitz: "You're a very strange man, Claus."
Claus von Bulow: "You have no idea."
-From Reversal of Fortune

During 2008, Sunny von Bulow died after 28 years in a coma. Her husband, Claus von Bulow was initially tried and convicted for attempted murder in 1982 but was later exonerated by Harvard Law professor Alan Dershowitz. This was dramatized in a movie, Reversal of Fortune.

Nevertheless, Sunny's family continued to believe that Claus was responsible for Sunny's condition. Two of Sunny's children from a previous marriage sued Claus for $56 million.

Meanwhile, Sunny's mother, Annie Laurie (Crawford) Aitken, disinherited Cosima von Bulow (Sunny's daughter with Claus) because she had sided with her father during the trial.

Clause von Bulow then resolved both matters by renouncing his share of Sunny's $75 million estate (redirecting those funds through her estate) and in return he was able to have his daughter Cosima reinstated as an heir of her grandmother.