SEPARATION DOES NOT EQUAL DIVORCE

A husband and wife enter into a prenuptial agreement. The agreement provides that it continues to apply even through "separation and reconciliation." Instead of separating and reconciling, the couple divorces and remarries. The issue arises whether the agreement continues to apply to the new marriage.

This was the issue in a recent Florida case, where after remarriage the husband died, and the wife sought to exercise property rights she had given up under the prenuptial agreement. Do you think the agreement continued to apply - that is, does "separation and reconciliation" mean the same thing as "divorce and remarriage?"

In my mind, the answer is no way - divorce is the legal dissolution of marriage - separation is just that, the parties ceasing to live together but without divorce. The trial court didn't agree with me (or the surviving wife), and held that "separation and reconciliation" = "divorce and remarriage," and thus the agreement continued to apply to the new marriage. It held this, even though as a general rule a prenuptial agreement does not survive the termination of a marriage.

The appellate court did read it my way, however.  It reversed the trial court, holding that the wife was free of the prenuptial agreement after the divorce, and that the "separation and reconciliation language" did not carry it over to the remarriage.

Clients often wonder why lawyers often take 10 words to say something in an agreement that could have been said in 5. This case is one reason - no matter how obvious a word may seem, sometimes you have to add a lot more language to make sure every knows what you meant if the parties want to fight about it. Its also a little bit scary, since this is not the first time I have seen plain language distorted by a trial judge beyond what was ever intended or its common, everyday meaning. Luckily, the appellate court was able to correct the error in this case, but there are instances where it is not economically viable to appeal or where the appellate court is not of a mind to disturb the ruling of the trial court.

SVETLANA A. OZEROVA HERPICH v. THE ESTATE OF HOWARD M. HERPICH, 33 Fla. L. Weekly D2653a, (5th DCA), Case No. 5D07-3920. Opinion filed November 14, 2008.

IRS TARGETS SALE OF CHARITABLE TRUST INTEREST TRANSACTION

Taxpayers often use charitable remainder trusts to avoid current tax on appreciated property. This is usually accomplished by the contribution of appreciated property to a charitable remainder trust, and then the trust sells the asset. Since the trust is tax-exempt, no current income tax is due on the sale. However, under the tiered income rules, as distributions are made to the grantor, those gains will be taxable to the grantor. Therefore, such planning is usually a deferral mechanism, not a tax elimination mechanism.

Some taxpayers have gone further. After the trust sells the property, the grantor and the charitable remainder beneficiary sell their trust interests to a third party. The grantor claims a stepped-up basis in his or her retained interest in the trust, and thus that there is no gain on the sale. The grantor also claims to avoid the uniform basis rules (which would apply a $0 basis to the grantor's interest) by reason of the combined sale with the remainderman. Thus, the grantor effectively gets a large chunk of change equal to the retained value of his or her trust interest, without incurring any income tax - and the gain on the sale of the contributed property is never taxed.

In a recent Notice, the IRS has indicated that it does not believe that the grantor gets the step-up in basis from the sale of the property by the charitable remainder trust. However, it has gone further than just making its views public - it has declared such transactions to be a "transaction of interest." As a transaction of interest, persons entering into these transactions on or after November 2, 2006, must disclose the transaction to the IRS. Further, advisors who make a tax statement on or after November 2, 2006, with respect to transactions entered into on or after November 2, 2006, have disclosure and list maintenance obligations. Failure to comply with such requirements can result in significant penalties.

Notice 2008-99, October 31, 2008

OBAMA AND ESTATE TAXES -WHAT TO EXPECT?

Presently, the unified credit is scheduled to shelter $3.5 million in assets per person in 2009. In 2010, there is no estate tax. In 2011, the unified credit is scheduled to return to $1 million.

What can we expect of President-Elect Obama? Of course, its too soon to tell, but his campaign promise was to make permanent the 2009 rates and credit - a $3.5 million unified credit equivalent and a 45% maximum estate tax rate.

An interesting question that has received very little attention is whether legislative changes in this area will repeal the scheduled elimination of the step-up in basis provisions (which provisions adjust the basis of assets of a decedent to the estate tax values). This elimination is scheduled to begin in 2010, although some step-up is allowed for in smaller estates.

Not allowing for a basis step-up will create a bookeeping nightmare for taxpayers, who will have to somehow figure out for inherited property what the decedent paid for the property and what basis adjustments may have occurred during the decedent’s lifetime. Let’s keep our fingers crossed that Congress will repeal the elimination as part of the expected revisions to estate and gift taxes.