Article Abstract – Preferred Interest Partnerships to Use DSUE Amounts Received by a Surviving Spouse

 

TITLE	Tasty Freeze: Preferred Partnership Tax-Saving Recipe
AUTHOR(S)	Michael N. Gooen and Tracy A. Snow
PUBLICATION	Estate Planning Journal - May 2015
PUBLISHER	WG&L
ABSTRACT (Key Points & Discussions)	Surviving spouse's can obtain the use of the unused unified credit amounts of their predeceased spouse (DSUE) if a portability election is made. However, if the surviving spouse remarries, and their new spouse dies before them, then the DSUE from the first spouse is lost and the DSUE, if any, from the latest spouse to die applies instead. If this new spouse has a smaller DSUE than the first spouse that died, the surviving spouse's estate ends up with a smaller available DSUE. To avoid this, surviving spouse's will often want to make a gift to use up the DSUE of their first deceased spouse before they remarry. If the DSUE of that first deceased spouse is used by the surviving spouse during lifetime before the death of a new spouse, the surviving spouse does not lose the benefit of that first deceased spouse's DSUE amount. However, often the surviving spouse is not comfortable gifting away significant assets for this purpose - he or she may need those assets for support or for a rainy day fund. The authors suggest that the surviving spouse capitalize a partnership with preferred and common interests, and then gift away the common interests. It is intended that the surviving spouse INTENTIONALLY triggers Section 2701, which results in the surviving spouse making a taxable gift that includes both the value of the transferred common interest, AND the preferred interest retained by the surviving spouse (which preferred interest has the lion's share of the real value). The surviving spouse uses the DSUE amount to avoid gift tax on this transfer. At the surviving spouse's later death, all growth in the partnership in excess of the preferred payments paid to the surviving spouse will have been transferred free of transfer tax to the gift recipients of the common share, based on the nature of the common interest and the frozen upside of the preferred interest. While the retained preferred interest of the surviving spouse will be subject to estate tax inclusion, there will be an offsetting reduction for the amount of that interest that was previously subject to gift tax under Section 2701, thus not creating any additional overall transfer taxes. The surviving spouse has thus (a) been able to use the DSUE to make a gift, even though still retaining cash flow from the gift via the retained preferred interest, and (b) shifted post-formation appreciation to the gift recipients free of transfer taxes. A step-up in basis for the spouse's retained interest may also apply, which can be applied within the partnership via a Section 754 election. Other possible enhancements to this technique include making the transfer to a defective grantor trust (so that the surviving spouse has to pay the income taxes on the transferred interest and thus reduces the size of her estate without taxable gift), and making the preferred interest of the spouse noncumulative (so as to preserve flexibility to limit unnecessary growth in the spouse's estate).
RESEARCH TAGS	DSUE, Partnership Freeze

 

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SURVIVING SPOUSE NOT OBLIGATED TO REFILE HOMESTEAD EXEMPTION–MARTIN COUNTY’S $283,070 TAX BILL VOIDED [FLORIDA]

Florida taxpayers that apply for and receive a homestead exemption receive a reduction on their ad valorem taxes. Perhaps more importantly, the homestead become subject to the "Save Our Homes" annual 3% limit on increases in value of the homestead for ad valorem purposes.

A husband purchased a residence in Martin County in 1985 and applied for and received homestead exemption. In 1985 he married and in 2000 he conveyed the house to himself and his wife as tenants by the entireties. Both the husband and the wife occupy the house as their primary residence. The wife never applied for homestead exemption in her name.

The husband died in 2006. The wife did not notify the property appraiser of his demise, and did not apply for homestead exemption. From 2007 to 2011, the property appraiser allowed a reduced tax for homestead and applied the Save Our Homes assessment cap to the wife. After learning about the husband's death in 2012, the property appraiser sought to collect $283,070.45 for additional taxes due to the reversal of homestead status from 2007 to 2011, plus a 50% penalty and 15% interest per year, since the wife never applied for homestead in her own name.

At first review, one might side with the property appraiser. Florida Statutes Section 196.011(9)(a) provides that a county may allow for automatic renewal of homestead status without the need for an annual application or statement. However, that statute provides "Notwithstanding such waiver, refiling of an application or statement shall be required when any property granted an exemption is sold or otherwise disposed of, when the ownership changes in any manner, when the applicant for homestead exemption ceases to use the property as his or her homestead, or when the status of the owner changes so as to change the exempt status of the property” (emphasis added). Ownership did change when the husband died, although the statute does not define "ownership change" for this purpose. Further, the above statute also applies when one's "ceases to use the property as his or her homestead" - it would seem the husband met that test when he died.

Florida Statutes Section 193.155(3)(a), in addressing assessments under the Save Our Homes assessment cap, also discusses changes of ownership. Unlike Chapter 196, this provision does define "change of ownership" and specifically provides transfers of legal or equitable title between a husband and wife, including a change to a surviving spouse is not a change of ownership. However, since this definition is in a different Chapter than Chapter 196, and that the cited provision says it applies only for purposes of that Section, one would think that provision does not apply for purposes of Section 196.011(9)(a).

Nonetheless, both the trial court and the Fourth DCA have ruled that the definition of change of ownership under the Save Our Homes provision should apply for purposes of defining an ownership change in Section 196.011(9)(a). The Fourth DCA said that “[t]o interpret otherwise would create a conundrum, where a surviving spouse would qualify for renewal of the “Save Our Homes” assessment cap but not for renewal of the homestead exception. Such a result is not consistent with the homestead exemption's purpose of shielding Floridians from undue financial hardship related to a home after a person has experienced one of life's most stressful events, the death of a spouse.”

The Fourth DCA also relied on the legal fiction that because entireties law views the cotenants as one owner, there was no change of ownership when the husband died.

The courts were correct that there would be a conundrum and a disconnect if the wife here obtain the benefit of the Save Our Homes assessment limitations if the property did not otherwise qualify for homestead exemption status, and thus this probably justified its liberal statutory interpretation. The case also serves as a useful reminder that heirs of a decedent that succeed to homestead property need to file their own homestead application if they will use that property as their homestead. Conservatively, even surviving joint tenants by the entireties should do so, unless they reside in the Fourth DCA and thus can rely on this case.

AUREL KELLY, as Martin County Property Appraiser, and RUTH PIETRUSZEWSKI, as Martin County Tax Collector v. MARY JANE SPAIN, 40 Fla. L. Weekly D513a, 4th District. Case No. 4D14-510, February 25, 2015.

Threat of Litigation Eliminates Charitable Set Aside Deduction for Estate

Estates and trusts with charitable beneficiaries often seek to employ the Code Section 642(c) charitable set aside deduction for income earned by the estate and trust that will eventually (but not in the current tax year) be distributed to the charity. This deduction is needed when the income cannot be currently distributed, since in that case neither a distribution deduction nor a charitable deduction would otherwise be available. Oftentimes, income cannot be currently distributed because it is too early in the administrative process to distribute to the beneficiary, especially when the beneficiary is a residuary beneficiary.

Code Section 642(c) will allow a deduction to the estate or trust in the year income is earned if the income is permanently set aside for a charitable purpose.  However, Treas. Reg. §1.642(c)-2(d) provides that no amount will be considered permanently set aside  “unless under the terms of the governing instrument and the circumstances of the particular case, the possibility that the amount set aside...will not be devoted to such purpose or use is so remote as to be negligible.”

In a recent Tax Court case, there was a charitable residuary beneficiary, and there was income earned in a year that was not paid out to the charity in that year. Subsequent to the earning of the income, the estate was engaged in litigation with another beneficiary. The charity did not receive all of the previously earned income due to expenses of the litigation.

The IRS asserted, and the Tax Court agreed, that the charging of the set-aside amounts with litigation expenses was not “so remote as to be negligible,” and thus disallowed the charitable set-aside deduction. The Court borrowed from case law in other contexts to equate “so remote as to be negligible” as meaning “a chance which persons generally would disregard as so highly improbable that it might be ignored with reasonable safety in undertaking a serious business transaction” or ““a chance which every dictate of reason would justify an intelligent person in disregarding as so highly improbable and remote as to be lacking in reason and substance.”

Under the facts of the case, the Tax Court found clear indications that at the time of the set-aside, there was a reasonable likelihood of litigation and that the costs of such litigation could impact the funds ultimately passing to the charitable residuary beneficiary. Thus, no set-aside deduction was allowed

It is important to note that the estate did not lose the set-aside deduction only on the set-aside funds actually expended on the litigation, but on the entire set-aside amount even though a large portion of the set-aside was not applied to the litigation expenses. It is not a question of the actual amount of funds applied out of the set-aside that is relevant – what is relevant is how much of the set-aside is at risk of being lost such that the risk of loss is not “so remote as to be negligible.”

It would have been helpful for the court to have specifically ruled that the entire amount was at risk to litigation expenses and the remaining administrative expenses (i.e., that the risk to the whole income amount was more than negligible. By not doing so and disallowing the entire set-aside deduction, it is unclear if the case can be stretched to support an interpretation that the entire set-aside can be lost even if only a PORTION of the income that was set-aside was at risk which risk was more than so remote as to be negligible.

Estate of Eileen S. Belmont, et al.v. Commissioner, 144 T.C. No. 6