The New York Court of Appeals has broken new ground.  It has held that an attorney may be held liable for damages resulting from negligent representation in estate tax planning that causes enhanced estate tax liability.  The court held that a personal representative of an estate may maintain a legal malpractice claim for such pecuniary losses to the estate.  The case is Estate of Saul Schneider, Appellant, v Victor M. Finmann, et al., Respondents, New York Court of Appeals Opinion No. 104 (June 17, 2010), 2010 NY Slip Op 5281.

The case involved a $1 million life insurance policy that was included in the decedent’s estate for estate tax purposes.

Before this case, NY courts have applied a strict privity rule, that lawyers owe no duty of care to non-clients, and only a client may sue a lawyer for legal malpractice.   As the New York Appeals Court Jude pointed out, the application of the privity rule "leaves the estate with no recourse against an attorney who planned the estate negligently."  The opinion stated: "We now hold that privity, or a relationship sufficiently approaching privity, exists between the personal representative of an estate and the estate planning attorney."

Further:  "The personal representative of an estate should not be prevented from raising a negligent estate planning claim against the attorney who caused harm to the estate," Judge Jones wrote. "The attorney estate planner surely knows that minimizing the tax burden of the estate is one of the central tasks entrusted to the professional."

The court made it clear, however, that strict privity should remain a bar against malpractice suits launched by estate beneficiaries or other third parties absent fraud claims or other special circumstances.

 I recommend that you read Steve Leimberg’s insightful comments on the case in his newsletter at LISI Estate Planning Newsletter # 1660 (June 19, 2010) at http://www.leimbergservices.com Copyright 2010 Leimberg Information Services, Inc. (LISI).

Aron Heller writes for the AP:

"JERUSALEM – It seems almost Kafkaesque: Ten safety deposit boxes of never-published writings by Franz Kafka, their exact contents unknown, are trapped in courts and bureaucracy, much like one of the nightmarish visions created by the author himself.

The papers, retrieved from bank vaults where they have sat untouched and unread for decades, could shed new light on one of literature’s darkest figures.

In the past week, the pages have been pulled from safety deposit boxes in Tel Aviv and Zurich, Switzerland, on the order of an Israeli court over the objections of two elderly women who claim to have inherited them from their mother."  Click here to read the rest of Heller’s article.

From Wikipedia:

"Kafkaesque" is an eponym used to describe concepts, situations, and ideas which are reminiscent of the literary work of the Austro-Hungarian writer Franz Kafka, particularly his novels The Trial and The Castle, and the novella The Metamorphosis.

The term, which is quite fluid in definition, has also been described as "marked by a senseless, disorienting, often menacing complexity: Kafkaesque bureaucracies"[1] and "marked by surreal distortion and often a sense of impending danger: Kafkaesque fantasies of the impassive interrogation, the false trial, the confiscated passport … haunt his innocence" — The New Yorker.[2]

Hat tip to Wills, Trusts and Estates Prof Blog – read his summary here.

Juan Altunez writes in his Florida Probate and Trust Litigation Blog about this recient Florida Supreme Court case:  Olmstead v. F.T.C., — So.3d —-, 2010 WL 2518106 (Fla. Jun 24, 2010). Read his execllent summary and anlaysis of the case here.

An excerpt from the post:

"For those of you interested in understanding the charging-order policy issue I think is lurking in the background of the Florida Supreme Court’s ruling, STARTrightLLC.com is an excellent starting point. Below is an excerpt from that website explaining why charging-order protection makes sense in a multi-member LLC scenario, and why it doesn’t make sense for single-member LLCs.

The charging order protects the company and the member’s investment if one of the members is sued in his or her personal life. . . . The original charging order philosophy protected guys A, B from having to accept D as an unwanted partner if C, the person they originally went into business with gets sued. They don’t want to have to deal with D. To prevent this unwanted member . . . the charging order is all D can get out of C’s membership . . . The charging order limits D. He must wait for A and B to decide to distribute money. No distributions = no money.

The Single Member Hitch: When a the member of a single member LLC is sued, there is no other member to protect from D. Two bankruptcy courts have used this flaw in the LLC protection to allow creditors of a business owner to completely take over his LLC and liquidate it for cash. The first case was in Colorado and the nation held its breath to see what would happen next. The next case was in Idaho and actually used the Colorado case to base its decision on. This means the trend is starting to move in the direction of denying charging order protection to single member LLCs."

 

 

Remember when Treasury Secretary Timothy Geithner ran into trouble because he hadn’t paid his self-employment tax? There was quite a political stir because it meant a tax-evader would be in charge of the IRS.

Geithner had worked at the International Monetary Fund from 2001 to 2004. During those four years, he paid no social security or Medicare taxes. American citizens who are IMF employees don’t have FICA and Medicare tax withheld from the paychecks because it is an international agency. They are considered to be self-employed and are supposed to treat the income as "self-employment" earnings, paying both employer and employee payroll taxes on the income.

The IRS audited Geithner in 2006 and discovered the problem for his 2003 and 2004 returns. Geithner paid just under $17,000 at the time, and the IRS waived any possible penalties. A three-year statute of limitations precluded the IRS from auditing the 2001 and 2002 tax returns. Geithner didn’t volunteer to look over 2001 and 2002 returns even though they contained the same mistake as the 2003 and 2004 returns. The additional amounts for 2001 and 2002 ($25,000) were discovered by the Obama vetting team and Geithner promptly paid up.

Mr. Geithner testified before Congress that he self-prepared his returns using Turbo Tax and that the error was a careless mistake. He paid his over-due social security taxes without penalty, and went on to become the Secretary of the Treasury. Did you ever wonder if it would work for the rest of us?

On June 21, 2010, the U.S. Tax Court handed down a decision in the case of another IMF employee, David Cameron Parker. Mr. Parker also failed to pay self-employment tax, used Turbo Tax to self-prepare his tax returns, and due to that fact argued that he had reasonable cause and acted with good faith with regard to the underpayment. Mr. Parker initiated contact with the IRS and voluntarily came forward with the problem, requesting a waiver of penalties. (He wasn’t caught in an audit.)

From May 25, 2005 through 2006, Mr. Parker earned gross annual compensation of approximately $175,000 while working for the IMF. On his 2005 return, Mr. Parker reported a tax liability of $20,212, which was about $12,000 less than what he actually owed. He asserted that he believed Turbo Tax included the self-employment tax in the tax he owed. He claimed that he called TurboTax and specifically asked "an expert" if self-employment taxes were included. He claimed the "expert" said they were included.

The Court did not believe such a conversation took place, since there were no self-employment taxes shown on the return. As for acting in "good faith" by initiating contact with the IRS regarding the underpayment, good faith must be shown before and during the act of filing. No later acts are included in the "good faith" definition. The IRS refused to waive penalties and the Tax Court backed up the IRS. Here is an excerpt from the opinion, Parker v. Commissioner, T.C. Summ. Op. 2010-78 (June 21, 2010):

"We shall address briefly petitioner’s contention that the IRS granted "favorable treatment" in a case involving U.S. Secretary of the Treasury Timothy Geithner, which petitioner described as "incredibly similar" to the instant case. According to petitioner, "there should not be different, or favorable rules for the well-connected". The record in this case does not establish any facts relating to the case to which petitioner refers involving U.S. Secretary of the Treasury Timothy Geithner. In any event, those facts would be irrelevant to our resolution of the issue presented here. Regardless of the facts and circumstances relating to the case to which petitioner refers involving U.S. Secretary of the Treasury Timothy Geithner, petitioner is required to establish on the basis of the facts and circumstances that are established by the record in his own case that there was reasonable cause for, and that he acted in good faith with respect to, the underpayment for each of his taxable years 2005 and 2006 that is attributable to his failure to report self-employment tax."

Similarly situated taxpayers should be treated similarly. The Tax Court was not necessarily wrong in the Parker case. There are other cases holding that reliance on tax preparation software is not enough to escape penalties. The problem is that Geithner should have had to pay the penalty as well.

David Kocieniewski reports for The New York Times: (click here for full article)

"A Texas pipeline tycoon who died two months ago may become the first American billionaire allowed to pass his fortune to his children and grandchildren tax-free, The New York Times’s David Kocieniewski reports.

Dan L. Duncan, a soft-spoken farm boy who started with $10,000 and two propane trucks, and built a network of natural gas processing plants and pipelines that made him the richest person in Houston, died in late March of a brain hemorrhage at 77.

Had his life ended three months earlier, Mr. Duncan’s riches — Forbes magazine estimated his worth at $9 billion, ranking him as the 74th wealthiest in the world — would have been subject to a federal tax of at least 45 percent. If he had lived past Jan. 1, 2011, the rate would be even higher — 55 percent.

Instead, because Congress allowed the tax to lapse for one year and gave all estates a free pass in 2010, Mr. Duncan’s four children and four grandchildren stand to collect billions that in any other year would have gone to the Treasury."

BUT DON’T FORGET ABOUT CARRY-OVER BASIS:  New Carry-Over Basis Rules for 2010

The fact that there is no estate tax is only half of the story.  The heirs will have to take over the decedent’s basis in all assets and income tax liabilities will be huge on liquidation of assets.  Its not the free pass it appears to be at first blush.

 "Discourage litigation. Persuade your neighbors to compromise whenever you can. Point out to them how the nominal winner is often a real loser – in fees, expenses and waste of time."                                                                                  ——–Abraham Lincoln

 

Lincoln’s words are doubly true today. Our society is beset with litigation – and all too often, there are no winners, except, perhaps, the lawyers. People need alternative means for resolving disputes.

Mediation, as a means of dispute resolution, is widely used in divorce and child custody disputes and is becoming more common in general civil litigation matters. There is a growing interest in using mediation to solve disputes related to wills and trusts.

In mediation an experienced neutral party attempts to assist the parties to air their concerns, understand each other’s point of view, and find a common ground. No decision is rendered; the mediator facilitates the parties’ arriving at their own solution.

Arbitration is the private, judicial determination of a dispute, by an independent third party. An arbitration hearing may involve the use of an individual arbitrator or a tribunal. A tribunal may consist of any number of arbitrators though some legal systems insist on an odd number for obvious reasons of wishing to avoid a tie. The disputing parties hand over their power to decide the dispute to the arbitrator(s). Arbitration is an alternative to court action, and generally, just as final and binding (unlike mediation is generally non-binding).

Arbitration is a growing field, providing a way of settling disputes without resort to the public courts, which are perceived by many litigants to be a broken system. Arbitration provides a way to "opt out" of the court system with its attendant delays, crowded dockets, and expense. The parties can have more control over the process and they can also choose a neutral with relevant experience.

Mediation Contrasted with Litigation and Arbitration

Both litigation and arbitration seek a winner and a loser and are adversarial procedures – usually further alienating the parties from each other. Many professionals believe that only through mediation is it possible to resolve the dispute and at the same time achieve reconciliation – restoring and improving the relations between the parties. Because of the possibility of reconciliation, mediation is an excellent approach for family disputes including disputes over estates and inheritances.

A mediator is not a therapist and does not act like one. But a mediator can provide for an airing of differences before they reach critical mass for an explosion. While there is no technical legal requirement that a mediator be a lawyer, considering the complex property law and tax issues presented in the trusts and estates field, a lawyer is likely the most effective mediator. The mediator must be able to assess the relative strengths and weaknesses of the parties’ arguments and must be completely independent with respect to all the parties.

In mediation the parties control the process, and there is no risk of an adverse decision since the mediator does not render a decision or judgment. Nothing said during the mediation can be used as evidence later at trial. The process is completely confidential and solutions can be arrived at that could not be ordered by the court as legal or equitable remedies – for example, an opportunity to air grievances or receive an apology.

Mediation in Estate Settlement

The death of a family member often sets the stage for conflict within the family. The traditional method of settling disputes that arise in estate administration is the litigation process from the formal pleading and response to trial and appeal. This can be extremely time-consuming and astonishingly expensive. As a result of the litigation process, family relationships can be left in tatters or completely destroyed. Not only is the inheritance consumed by fees, but the family is consumed by anger and hatred.

While widely used in divorce and child custody disputes, few jurisdictions look to mediation in disputes involving wills and trusts. The time has come to give these disputants the same chance at resolving issues and maintaining family relationships. There is nothing to stop disputants from seeking mediation privately. Parties to any dispute can seek mediation. Lawyers need to be alerted to the possibility of seeking this kind of resolution and trained away from the immediate reaction of pursuing claims in court.

Here are two examples of situations where mediation can be used:

(1) A beneficiary who believes he or she should get a bigger share of the estate may have only one alternative in the courts: invalidating the will and even that may not bring the desired result. Not only is this difficult to do and causes dissatisfied beneficiaries to mount will contests when there really is insufficient evidence for such a case, but also there are limited opportunities to reach a different result. Usually, as a result of litigation, either the will is valid or it isn’t. Through mediation an accommodation could be reached.

(2) Current family structures have created family relationships that are not adequately addressed by existing law. In addition to blended families with children who are "yours, mine and ours," there are same sex adoptions, children of single parents, and children born of surrogate mothers and artificial insemination. There are a host of issues here that could be worked out through mediation.

 Mediation in Trustee-Beneficiary Disputes

Who has not heard beneficiaries complaining about trustees? Often beneficiaries are critical of the trustee’s investments, the trustee’s exercise (or non-exercise) of its discretionary powers, the trustee’s unresponsiveness. Often the beneficiary does not understand the restrictions on the trustee’s actions, and the trustee fails to communicate effectively. The trustee- beneficiary relationship can begin to resemble the caricature presented in the old TV sitcom starring Lucille Ball as Lucy Carmichael who is always conniving against Mr. Mooney (played by Gale Gordon), the trust officer who administered her deceased husband’s trust.

Many disputes of this nature can be solved by mediation before the parties’ positions become polarized in litigation. When the trustee’s exercise of discretion is involved, mediation is the best answer. Seldom can a trustee be forced to exercise discretion and seldom can a beneficiary be reconciled to a steady diet of "no" from the trustee for every request.

Family settlements are favored by the law in probate matters. Courts generally enforce these settlement agreement in the absence of fraud. States where the Uniform Trust Act with its provisions for virtual representation and non-judicial settlement agreements has been adopted provide an excellent environment for trustee-beneficiary dispute resolution through agreements reached via mediation.

Mediation in Estate Planning

Much is at risk in estate planning, and the most important is not estate taxes. The most important factors are the beneficiaries, their lives and their relationships – in other words, family. Estate planning aims at the transfer of wealth from one generation to another in a way which minimizes taxes and maximizes economic gain. At bottom, it usually involves parents making gifts to their children, grandchildren or charities. The problem is that while many clients spend hours with attorneys, accountants and financial advisors crafting an estate plan, they spend no time with their intended beneficiaries explaining what they have done and why. After Mom and Dad are gone, the family acrimony begins – brother sues brother and sisters stop talking to one another for years.

Since your typical family has trouble communicating about day to day activities such as what to have for dinner; perhaps, it is no surprise that the typical family cannot and does not communicate about dying, property division, and settling estates. Nevertheless, communicating the plan and addressing the issues before death is the best gift that can be given to beneficiaries.

It is not bad manners to talk about the estate plan, and it will not make matters worse. What makes matters worse is leaving the children to fight it out after Mom and Dad are both gone. If Mom and Dad are afraid to tell the kids what they’ve done in their estate plan, they are leaving a legacy of acrimony. A mediator will recognize that it is up to Mom and Dad to determine what they will do with their assets and that Mom and Dad want all family members to feel as good as possible about the estate plan and not feel cheated or disappointed. Bringing all the parties together can ensure that hidden agendas are brought out into the open, get the most buy-in from the parties and get the best protection against the plan being contested.

Mom and Dad need to be shown that spending some time and money now on a process of mediation can save thousands of dollars later and, more importantly, can preserve family relationships that are more precious than money.

Mediation is not family therapy. It is a short-term process aimed at resolving a dispute while attempting to preserve family relationships. It depends on opening lines of communication and coming up with solutions.

Mediation can also be used to discuss long term care issues with parents, to determine how siblings can equitably share the responsibility of helping aging parents, and how to deal with care givers and medical personnel. Disputed guardianships are perfect for mediation – nothing is worse than the public airing of dirty linen that a contested guardianship hearing brings out. 
 

Drafting for Mediation and Arbitration

As far as the estate planning documents themselves go, one can include provisions that require the parties to submit disputes to private mediation or arbitration rather than resort to the courts. Many texts point out that George Washington’s will contained such a provision:

 "That all disputes (if unhappily they should arise) shall be decided by three impartial and intelligent men, known for their probity and good understanding; two to be chose by the disputants each having the choice of one, and the third by those two – which three men thus chosen shall, unfettered by law or legal construction, declare their sense of the Testator’s intention; and such decision is, to all intents and purposes, to be as binding as if it had been given in the Supreme Court of the United States."

The general principles of arbitration are (1) to obtain a fair resolution of disputes by an impartial third party without unnecessary expense or delay, (2) allow parties to agree how their disputes are resolved, subject only to such safeguards as are necessary in the public interest, and (3) courts are not involved.

Arbitration is entered into by consent of the parties, either after the dispute arises, or by signing a contract that provides for arbitration of disputes. An example of a common contract with arbitration provisions is a typical account agreement with a stock broker where the account holder agrees that all disputes will be resolved by arbitration.

In the probate and trust context, the testator can direct arbitration, the parties can agree to arbitration in advance in a document (e.g. a deed of trust), the parties can agree to arbitration before litigation begins, or a court can direct it.

Will courts enforce an arbitration clause in a will or trust? John K. Boyce, III, in his article, "The Use of Arbitration Clauses in Estate and Trusts," Alternative Resolutions, The Newsletter of the State Bar of Texas, Vol 14, No. 4, pp. 19-20) states: "Today . . . .while arbitration provisions are becoming common, even ubiquitous, in certain kinds of business contracts, in construction contracts, and even in employment agreements, they still are not widely used in wills or inter vivos trusts, despite George Washington’s example and the wholehearted acceptance of arbitration at the state and federal level. . . . Beneficiaries under a will, trust, or similar instrument are almost never parties to the agreement and therefore are almost never in a position to have agreed to arbitration before a dispute arises. I believe that this is the reason we have not seen arbitration clauses used more widely in connection with wills and the like, despite the fact that the advantages arbitration offers are the same in a dispute arising under a trust as they are in a dispute arising under a contract, and despite the fact that these advantages are widely recognized."One of the solutions Boyce comes up with is to couple the arbitration clause with an in terrorem clause. For example, if a beneficiary refuses to arbitrate a dispute, he or she forfeits his or her interest in the estate or trust.

The American Arbitration Association provides a standard arbitration clause for incorporation in estate planning documents:

 "In order to save the cost of court proceedings and promote the prompt and final resolution of any dispute regarding the interpretation of my will (or my trust) or the administration of my estate or any trust under my will (or my trust), I direct that any such dispute shall be settled by arbitration administered by the American Arbitration Association under its Arbitration Rules for Wills and Trusts then in effect. Nevertheless the following matters shall not be arbitrable questions regarding my competency, attempts to remove a fiduciary, or questions concerning the amount of bond of a fiduciary. In addition, arbitration may be waived by all sui juris parties in interest."

"The arbitrator(s) shall be a practicing lawyer licensed to practice law in the state whose laws govern my will (or my trust) and whose practice has been devoted primarily to wills and trusts for at least ten years. The arbitrator(s) shall apply the substantive law (and the law of remedies, if applicable) of the state whose laws govern my will (or my trust). The arbitrator’s decision shall not be appealable to any court, but shall be final and binding on any and all persons who have or may have an interest in my estate or any trust under my will (or my trust), including unborn or incapacitated persons, such as minors or incompetents. Judgment on the arbitrator’s award may be entered in any court having jurisdiction thereof."

Jonathan Blattmachr provides suggested document provisions in his article, "Reducing Estate and Trust Litigation Through Disclosure, In Terrorem Clauses, Mediation and Arbitration." John Phillips, Scott Martinsen and Matthew Damon also provide extensive sample provisions for inclusion in estate planning documents in their article, "Analyzing the Potential for ADR in Estate Planning Instruments," Alternatives Vol. 24 No. 1, January 2006, p. 1 et. seq.

The rising costs of formal litigation and its many delays coupled with the increase in fiduciary litigation of all types make the use of mediation and arbitration in the settlement of trusts and estates disputes a valuable tool. Planning ahead for the use of alternative dispute resolution by adding directions for dispute resolution in estate planning documents is an important step in preparing for use of these tools.

Conclusion

The rising costs of formal litigation and its many delays coupled with the increase in fiduciary litigation of all types make the use of mediation and arbitration in the settlement of trusts and estates disputes a valuable tool. Planning ahead for the use of alternative dispute resolution by adding directions for dispute resolution in estate planning documents is an important step in preparing for use of these tools.

Today I listened to the ALI-ABA Webcast "Virtual Representation in Trust and Estate Dispute Resolution:  Opportunities and Risks",  You can check at the ALI-ABA website to find out when the online version will be available – i highly recommend it.  This concept will be increasingly valuable in the resolution of trust and estates disputes.  The ALI-ABA course description reads: 

"Virtual representation," which has long-existed in the common law and is embodied in a variety of state statutory schemes, seeks to protect incapacitated, unborn, and unidentified beneficiaries who can’t protect themselves in trust and estate litigation. This doctrine has become an increasingly necessary tool to bind all parties whose interests are affected by the resolution of such disputes.  As the use of "virtual representatives" to bind absent parties increases, the risks for parties involved in trust and estate disputes of not identifying an appropriate virtual representative have also increased.

Here is a segment of my outline from the PBI seminar on Developments in Fiduciary Litigation:

Virtual Representation PEF Code §§ 7721-7726

  1. Virtual Representation PEF Code §§ 7721-7726

    History: "Virtual representation was a concept in Hanoverian Britain, based on the belief that men without the vote, such as persons in the colonies, or those in Britain who did not have the franchise, were "virtually represented" by Members of Parliament who had been elected by "similar" voters. There were some shopkeepers who voted for MPs, the theory went; therefore all shopkeepers were virtually represented. Men who owned property in North America voted for MPs—some, indeed, sat in Parliament. This, the advocates of virtual representation held, meant that American interests were virtually represented."

    A. "Virtual" means " not in fact"

    B. "The theory of virtual representation is that, if the interests of the representor and representee are closely aligned and are affected in the same way by the decision, the presence of the representor will be sufficient to make every argument that the represented party would make."

    C. Representatives provided there is no conflict of interest [emphasis added] with respect to the matter at issue:

    1.   Guardian represents the ward

    2.   Agent under a power of attorney represents the principal

    3.   Living sui juris members of class represent other class members who are minors, unborn, unknown or unascertained

    4.   Predecessors in interest – where property will pass to a person or class upon the occurrence of a future event, but will pass to another person or class upon the occurrence of an additional future event, the class who would take on the first event represent those who would take on the second event

    5.   Unknown or unascertained beneficiaries – Person represents all minors or unborn individuals or persons whose identity or location is unknown or not reasonably ascertainable if the interest of the persons represented are substantially identical with respect to the particular question or dispute involved.

    6.   Donee of a general power of appointment – represents all potential appointees (objects) and all takers in default even if a conflict of interest exists

    7.   Donee of a limited power of appointment – represents all potential appointees (objects) and all takers in default who are also potential appointees.

    B.  Judicial proceedings

    An order or decree binding the virtual representative is binding on the persons, or class of persons represented if the trustee notifies the representative in writing whom they represent and they do not decline representation and they act in good faith

    C.  Non-judicial proceedings

    Notice, consent, approval, waiver or release by the representative is binding on the persons, or class of persons represented if the trustee notifies the representative in writing whom they represent and the do not decline representation and they act in good faith.

Here we are four months into 2010 and there has been no change to the gift and estate tax law.  Most observers were surprised that a patch to continue the law as it stood in 2009 was not enacted.  Now there is talk of such a patch or even a new law that would accomplish it retroactively.  But the first truly rich American has died, a multi-billionaire who was number 74 on the world wealth rankings.  His estate has plenty of money to spend fighting any retroactive tax law as well as a lot of money to be saved if it prevails.  But what if nothing happens?

As a refresher, if the estate tax law of 2001 is allowed to expire then everyone’s estate can pass $1,000,000 free of federal estate tax. Above that, the estate is taxed on a rising bracket scheme until the top bracket of 55 percent is reached.  There is a surtax on estates over $10 million until the benefits of bracketing are gone and the estate is taxed at a flat 55 percent.  Also, the state tax paid is allowed as a credit, not just a deduction.  There is a table that shows what the IRS will accept as state death tax credit. It starts after $60 thousand and moves up in brackets until it reaches 16 percent.  This is the ultimate in revenue sharing because what you pay to your state is reduced dollar for dollar from your federal estate tax.  It was phased out in the four years following 2001 but would reappear if the current law is allowed to reach “sunset”.

Every state used that table as part of or all of their estate tax assessment.  It was called the state estate tax, or the slack tax, or the pickup tax.  When it was phased out, some states (the “time machine” states) adjusted their laws to levy tax as if the IRS law in effect before 2001 was still in effect.  Others, the “philosophical” group, just shrugged, apparently saying, “Easy come, easy go.”  Pennsylvania tried the “time machine” approach, but bracketed tax violates the state constitution, so it begrudgingly had to join the “philosophical” group.  While the state estate tax was always unconstitutional in Pennsylvania, it was never challenged in court because no one was injured by it (except maybe the IRS) and so there was no cause of action.  When credit for it started vanishing from the IRS credit list, a cause of action was created and thus the trip to the back of the “philosophical” line for Pennsylvania.

If sunset occurs, the states are ready to enjoy the benefit again.  Since U.S. Senators and Congressmen are well aware of their state’s financial problems, it seems they all have a motive to allow the “sun to set”.  But the federal government needs money too, so wouldn’t this cause an income problem for the U.S. Treasury?

The answer is yes and no, but mostly no.  Consider what Pennsylvania and the IRS collect on an estate under the 2009 regime and again under the 2011 sunset rules.  Assume the decedent is the second of a couple to die. There is almost never any tax for the first to die thanks to the unlimited spousal exemptions in both the federal and state tax law.  Assume all the estate will go to children or parents, for whom the state inheritance rate is 4.5 percent.

With an estate of $6 million, both the state and the US would end up with about twice as much income.  At $10 million, the state does about 2.4 times better, while the U.S. still does better but only by a factor of 1.37.  At $30 million, the factors are 3.16 and 1.05.  At $40 million, the factors are 3.26 and 1.01.  At a net estate of $44,337,107, the factors are 3.29 and 1.0.  The IRS actually takes in the same dollar amount.  Above this level, the state factor keeps getting better, but with a limit, while the IRS factor drops below 1.0.  At $250 million, the factors are 3.51 and 0.92.  At $1 billion, the factors are not much different, being 3.54 and 0.91.

Both taxing authorities improve their income in the ten million dollar range.  The state continues to improve until it collects about three and a half times more in the billion dollar range.  The IRS drops to break even at about $44 million and collects less than before above that amount but never dropping below 90 percent of what it had collected.  Estates pay more, since 55 percent is more than 45 percent.  But, more of the revenue stays in the state, which is a motive that could leave us seeing the sun set in 2011.