Estate Talks

Administration Expenses May Reduce Marital Deduction for Decedents Who Died Before December 2 2015

The U.S. District Court for the Central District of California recently held that administration expenses charged to a marital bequest may reduce the estate’s marital deduction if the decedent died before December 2, 2015, depending on whether the administration expenses are charged to principal or income or are interest payments.

This case involved a gross estate of about $180 million. Three years prior to the decedent’s death, he gave his wife money to pay gift

estate tax
Real Estate Concept

taxes associated with the funding of an insurance trust. Because of this, the IRS issued a notice of deficiency against the estate.

The district court determined that

1. Under §2056, administration expenses charged to the principal of the marital bequest reduced the estate’s marital deduction dollar-for-dollar;

2. Administration expenses charged to the income of the marital bequest did not reduce the estate’s marital deduction because they were under the 5% threshold of Justice O’Connor’s materiality test [Comr. v. Hubert Est., 520 U.S. 93 (1997)];

3. Under Rev. Rul. 93-48, 1993-2 C.B. 270, the estate’s interest payments on the tax deficiency did not reduce the marital deduction, regardless of whether they were a material limitation on the marital bequest.

Retroactive Estate Tax Increase Was Constitutional

The Appeals Court for the Federal Circuit held that §13208 of the Omnibus Reconciliation Act of 2003, which retroactively increased the top estate tax rate of 50% to 55%, is not unconstitutional.

On August 10, 2003, President Bush signed the Omnibus Budget Reconciliation Act of 2003 (OBRA) into law. Section 13208 of Title XIII of OBRA permanently increased the estate tax rate for taxable estates over $3 million from 50% to 55%, effective retroactively to January 1, 2003. The increase was made retroactive because President Bush had pocket-vetoed legislation in late 2002 that would have extended the 55% rate effective January 1, 2003. Since that bill was pocket-vetoed, the 55% rate lapsed to 50% until OBRA was signed.

In March 2003, Ellen Clayton died with a gross estate of more than $28 million. At that time, the applicable estate tax rate was 50% for estates over $3 million. The estate tax return for Ellen’s estate was filed after OBRA went into effect, so the executor (NationsBank, N.A.) paid the tax under the 55% rate, then sought a refund, arguing that the retroactive estate tax increase was unconstitutional because it violated several provisions of the Constitution, including

1. The separation of powers doctrine

2. The apportionment clause,

3. The ex post facto clause,

4. The takings clause,

5. The due process clause, and

6. The equal protection clause.

The Court of Federal claims disagreed and held that OBRA did not violate the Constitution. The Court of Appeals for the Federal Circuit affirmed that decision.

But what is the side effect of all this?

Low AFRs Mean Lower Gift Tax for GRATs

Question: I’ve heard that falling interest rates are beneficial for certain financial planning tools, particularly Grantor Retained Annuity Trusts (GRATs). Is this true? And if so, how does it work?

Answer: Yes, certain financial planning tools, including GRATs, can be more effective when interests rates are falling.

With a GRAT, the grantor transfers assets to the trust for a term of years. During that time, the grantor receives an annuity payment, and when the trust terminates, the assets are distributed to a noncharitable beneficiary, usually the grantor’s children.

The taxable value of the gift to the GRAT’s beneficiary is reduced by the value of the grantor’s annuity interest. These values are determined by the Applicable Federal Rates published monthly by the IRS. When the AFRs are low, the value of the grantor’s retained interest increases, and the taxable value of the gift decreases.