Sunday, August 22, 2010

Sad Day for New York Yankees, IRS

Some creditors are tougher than others. The mortgage company can take away your home and Tony Soprano can take your limbs, but the last creditor you'd ever want is the Internal Revenue Service. IRS liens cannot be evaded through time (interest and penalties are crushing, bankruptcy or even death. The heirs stand in line behind the IRS.

But when New York Yankees majority owner George Steinbrenner passed away last month - checking out at an estimated $1.1 billion net worth - he took more than his legacy of seven World Series championships. In addition, his heirs were left with an estate tax liability much smaller than any of them could have dreamed just a short time ago.

The top estate tax rate has varied over the last few decades, falling into the confiscatory rate of 46-55 per cent. The actual rate can substantially exceed 55 per cent, since most larger estates consist of non liquid assets which must be sold within nine months to pay the estate tax liability. Owners of lucrative sports teams are not exempt - this is how the heirs of Joe Robbie lost control of the Miami Dolphins.

But because of an anomaly in the estate tax law, George Steinbrenner's heirs will do somewhat better. Determining the liability is usually a tricky matter of applying the progressive tiers of rates to the fair market value of the gross estate less all applicable deductions. However, in George Steinbrenner's case, according to our calculations, it's $0, zero, zilch, nada, nothing, goose egg, zippity-doo-dah, not one penny, ni un centavo, the number of teams that will beat the Miami Heat this year, etc.

That’s because the Economic Growth and Tax Relief Reconciliation Act of 2001 - which gradually increased the amount of estate tax exempt assets from $675,000 in 2001 to $1,000,000 in 2002, up to $3,000,000 in 2009 - also provided for two things all the pundits were certain would never occur:

  1. the estate tax was completely eliminated in the year 2010; and
  2. EGTRRA "sunsets" in year 2011, returning to the days of a 55 per cent tax rate and a $1,000,000 exemption

So, George Steinbrenner, or, more accurately, his heirs, are the beneficiaries of item 1 - estate tax elimination for the year 2010 (this provision was referred to as the "Throw Momma From The Train" Act) and George Steinbrenner is not the only one of the “rich and famous” whose heirs will benefit from this anomaly.

But, wait! Why do you think Congress let EGTRRA sunset in the first place? - they needed the money! So, just for the year 2010, the estate tax was replaced by another tax: the loss of stepped-up basis at death.  In short, all the untaxed appreciation in assets owned by persons dying in 2010 are subject to capital gains tax when those assets are eventually sold by heirs.

How would this affect the estate of George Steinbrenner? Had he died a few months earlier his $1.1 billion estate would have incurred a liability of about $500 million. Under the 2010-only capital gains scheme, his estate could be among the hardest hit. Because he purchased his $880 interest in the Yankees for $10 million, almost all of his interest consists of built-in (and taxable) capital gains.

But let's compare that to the frugal "millionaire next door," who lived prudently and modestly and invested well, and passed away in 2010 with a much more modest, but still taxable estate. Assuming both estates had the same proportion of built-in capital gains, both are potentially exposed to the same level of capital gains taxes. But, as a practical matter, would the heirs wind up with the same proportion of the estates?

Not likely! The capital gains scheme offers an escape valve unavailable to heirs under the estate tax scheme, which requires taxes to be paid within nine months. Capital gains taxes cannot even be ascertained until the inherited asset is sold, leaving the heirs the option of simply holding on to the assets  until the opportune time to sell them and pay the taxes.

Who is likelier to be able to use this escape valve, the heirs of the "millionaire next door" or of George Steinbrenner? It's purely speculative, of course, but I would be surprised to see the Steinbrenner family selling its interest in the Yankees any time in the near future.

Their skill in managing baseball's highest payroll will, in part, determine whether they can add to the legacy of the seven World Series championships. If their tax managers are just as adept, their tax liability - for at least the foreseeable future - should still be $0.

Saturday, August 21, 2010

What Happens if Spot Outlives You?

Not everyone loves their pet, and if you fall into this category, read no further. We love Mia, our extremely fluffy Maltese-Shitzu, and so do her Facebook fans. If you "fan" her (dog lovers only, please), you will immediately spot that that she is quite the avid reader, especially of anything regarding dogs.

A recent Jenna's Dogs Blog post - Heiress Gail Posner's Dogs Inherit a Fortune - really made her fur stand up because it questioned the propriety of Conchita's (Ms. Posner's Chiahuahua) one third share of a $3 million inheritance. Naturally, Mia wasn't pleased:  

Pardon me for not living in medieval times, but what exactly is so wrong with a dog inheriting $1 million, other than it doesn't buy as much Iams as it used to? This blogger - and her canine hating readers - gets a lift o' the rear leg from dog lovers everywhere
Mia can be excused for taking it so caninistically. She is aware of a relatively new Florida Statute enabling those of us who cannot guarantee we will outlive our beloved pet to provide for them as long as they live.

Why would you want to include your pet in your estate planning? For many of the same reasons we've set up a "pet Trust" for Mia. We want to:
  • ensure someone we know who loves her will take care of her
  • provide the means for taking care of her
  • avoid the perils and delays of probate
It's purely a matter of personal preference, but (perhaps to Mia's chagrin) we haven't gone as far as Gail Posner or Leona Helmsley in terms of the amount. For most of us, it will be a relatively small portion of our estates. Perhaps not enough to keep her in Dom Perignon, driving a Porsche or weekending in Gstaad, but enough for food, exercise, vet bills and the care of someone who will love her almost as much as we do.

Where does the remainder of the trust go when Spot "moves on?" Anywhere you want! Perhaps your favorite charitable organization, such as your local animal shelter or the Humane Society.