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As a general rule, an irrevocable trust is a legal entity separate

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As a general rule, an irrevocable trust is a legal entity separate ...

     EFM: THE CUTTING EDGE

     Eizen Fineburg & McCarthy, P.C. Newsletter No. 3-03 Summer 2003

     consistency with the new laws and minimize death tax Decoupling of State and Federal liability.

     Death Taxes:

    This article focuses on the changes under EGTRRA What Does It Mean To Your which modify the federal estate tax exemption Estate Plan?(described below), phase out the federal credit for 1death taxes paid to a state by 25% each year By Ted M. Greenberg beginning in 2002, and eliminate the credit entirely in 2005. In 2005, EGTRRA replaces the federal state The Economic Growth and Tax Relief death tax credit with a deduction for state death taxes Reconciliation Act of 2001 (“EGTRRA”) is paid. impacting state death taxes as a result of the increase of the federal estate tax exemption Prior to the EGTRRA whether or not a death tax had and the gradual elimination of the federal state to be paid to the state depended on whether or not a death tax credit. We write this article for our federal estate tax was due to the Internal Revenue readers who are curious about the effects of Service. While significantly reducing federal estate EGTRRA on state death taxes and how it may taxes, EGTRRA had the effect of reducing death taxes impact your overall estate plan. in states where death taxes were based upon, or 2conformed to, the federal estate tax law. To preserve Under pre-EGTRRA law, most estates received their tax revenue, some of these states, such as a 100% credit against federal estate taxes for Pennsylvania and New Jersey, modified their death the state death taxes. Your estate was not out-tax laws to separate, or “decouple”, their death tax of-pocket any additional money. In essence, laws from the federal estate tax law. the federal government shared its total death taxes due with the state, costing the estate The federal estate tax exemption is the total amount nothing more. As a result of EGTRRA, your you can give away during your lifetime and/or at your estate no longer receives a 100% credit against death without incurring any federal gift or estate tax federal estate taxes for state death taxes. This 3liability. This amount is scheduled to increase over affected the amount of federal estate tax the next several years to $3,500,000 for persons dying dollars that the federal government shares with in 2009. The exemption will effectively be unlimited the states, and reduced state death tax for persons dying in 2010 (the year in which the revenues. Many states are responding to this federal estate tax is eliminated), and will return to loss of revenue by separating their state death $1,000,000 in 2011 when pre-EGTRRA law is tax systems from the federal estate tax 4restored. (described below). The change to the federal estate tax law and its impact at the state level The pre-EGTRRA federal credit for state death taxes make it even more important to take another provided a form of federal revenue sharing with the look at your overall estate plan, including your states. A number of states, including Pennsylvania, dispository documents such as wills and trusts, New Jersey and Florida, imposed an estate tax that the value and nature of your assets, the conformed to federal estate tax law. Estate tax manner in which your assets are held, the liability in those states was equal to the maximum ownership and beneficiaries under your life federal state death tax credit permitted under federal insurance and annuities, and the beneficiaries law, less the amount of inheritance and other death under your retirement accounts, to ensure taxes paid to the state. The result was a shifting of some estate tax dollars from the

    continued on next page . . .

     1 Ted M. Greenberg is the Chairman of EFM’s Estates, Trusts and Wealth Preservation Department. 2 See The Truth About the New Estate Tax & Gift Tax Laws, by Ted M. Greenberg, Cutting Edge June 2001 Special

    Edition. 3 Gifts to your spouse and gifts that qualify for the per donee annual gift tax exclusion (currently $11,000) do not

    consume your exemption. 4 Under EGTRRA, for estate tax purposes, the exemption is $1,000,000 in 2002 and 2003, $1,500,000 in 2004 and

    2005, $2,000,000 in 2006, 2007 and 2008, and $3,500,000 in 2009. Under pre-EGTRRA law, the exemption would

    have been $700,000 in 2002 and 2003, $850,000 in 2004, $950,000 in 2005, and $1,000,000 in 2006 and thereafter.

    federal government to the states without any 2003. Federal estate tax liability would be $0 (see increase in taxes at the taxpayer level. EGTRRA Example 2, above). To compute the estate tax due significantly reduced, and in 2005 effectively to Pennsylvania, a hypothetical federal estate tax eliminates, this shift of revenue to the states. This liability of $82,800 would be determined based on is best explained by way of examples. pre-EGTRRA law ($345,800 less a unified credit of $229,800 (derived from a 2003 pre-EGTRRA Example 1: Suppose a person with a exemption of $700,000), less the pre-EGTRRA taxable estate of $1,000,000 died in 2001 prior to maximum available federal state death tax credit the enactment of EGTRRA, a resident of a state of $33,200). Pennsylvania estate tax liability would that imposed an estate tax conforming to the be $33,200 (see Example 1, above). federal estate tax. Federal estate tax would be $92,050: $345,800 less a unified credit of Like Pennsylvania, New Jersey has decoupled its $220,550 (derived from a $675,000 exemption), estate tax from the federal estate tax. In New less the maximum available federal state death Jersey, however, the estate tax is determined tax credit of $33,200. $33,200, i.e., the amount of utilizing the 2001 federal exemption of $675,000. the maximum federal state death tax credit, would be paid to the state as an estate tax (assuming no Florida’s constitution prohibits it from decoupling other state death taxes are due). its estate tax from the federal estate tax. Accordingly, the Florida estate tax is determined Example 2: Suppose a person with a by reference to the EGTRRA exemption and taxable estate of $1,000,000 dies in 2003 a utilizing EGTRRA’s phased-out elimination of the resident of a state that imposes an estate tax federal state death tax credit. Florida estate tax conforming to the federal estate tax. Federal liability will be eliminated coincident with estate tax would be $0: $345,800 less a unified EGTRRA’s elimination and replacement of the credit of $345,800 (derived from a $1,000,000 federal state death tax credit in 2005. exemption). No federal state death tax credit would be available since there is no federal estate In a state that has decoupled its state estate tax tax liability to offset with the credit. Accordingly, from the federal estate tax, while an EGTRRA nothing would be paid to the state in the form of a exemption is used to determine federal estate tax state estate tax. liability, a pre-EGTTRA exemption may be used to determine state estate tax liability. As shown To maintain the estate tax revenue they would above, although the taxable estate may not have received under pre-EGTRRA law, a number exceed the EGTRRA exemption, a state estate tax of states, including Pennsylvania and New Jersey, may nevertheless arise. In the case of a married decoupled their estate tax from the federal estate couple where the first spouse to die establishes a tax. trust for the benefit of the surviving spouse to shelter his or her EGTRRA exemption, if that trust In Pennsylvania, the estate tax continues to be is fully funded with the EGTRRA exemption based on the maximum allowable federal state amount, state estate tax may arise with no death tax credit, but pre-EGTRRA law is applied. corresponding federal estate death tax credit. The maximum allowable federal state death tax Even if the state continues to use the EGTRRA credit is determined by utilizing the exemption that exemption but uses the pre-EGTRRA federal state would have been in effect but for the enactment of death credit to determine state estate tax liability, EGTRRA, and the phased-out elimination of the a state estate tax may arise with no corresponding 5federal state death tax credit is disregarded. This, federal estate death tax credit if the taxable state in effect, requires the preparation of two federal exceeds the EGTRRA exemption. This is a result estate tax returns: the actual return (applying of EGTRRA’s phased-out elimination of the federal

    federal estate tax law, as amended by EGTRRA) state death tax credit. to determine actual federal estate tax liability, and a Pennsylvania return (applying pre-EGTRRA Federal estate tax liability can be substantially federal estate tax law) for purposes of determining reduced, or even eliminated, particularly in the Pennsylvania estate taxes due. By way of case of married persons, by taking advantage of example: the increasing EGTRRA exemption. However, with

     decoupling, it is now more important than ever that

    Example 3: Suppose a Pennsylvania your estate plan be coordinated with the laws of resident with a taxable estate of $1,000,000 dies in the state where you reside. With proper planning,

    each spouse’s exemption can be used to effectively double the amount that can pass free of 5 See footnote 3.

    analogous to partners in a partnership than to federal estate tax to the children or substantially all, shareholders in a general corporation and, death tax liability until the death of the second therefore, should not be considered employees for spouse. In view of EGTRRA and the trend toward purposes of the federal antidiscrimination laws. decoupling, we strongly recommend that you take However, the United States Court of Appeals for another look at your overall estate plan. the Ninth Circuit reversed and remanded upon finding no reason "to permit a professional Supreme Court Sheds Some Light corporation to secure the 'best of both possible on the Definition of an Employee worlds' by allowing it to both assert its corporate status in order to reap the tax and civil liability under the ADA

    advantages and to argue that it is like a 6By Jill Santomero partnership in order to avoid liability for unlawful employment discrimination." In recent years, the Supreme Court has taken steps to limit the impact of the Americans with Ultimately, the United States Supreme Court held Disabilities Act (ADA) on employers. At present, that since the ADA does not define the term employers are only subject to the ADA if an "employee," the Court should look to the common employer's workforce includes 15 or more law in determining whether a shareholder-director employees for each working day in each of 20 or is an employee. In addition, the Court was more calendar weeks in the current or preceding admittedly quite persuaded by the Equal calendar year. Such employers are required to Employment Opportunity Commission's (EEOC) make reasonable accommodations for qualified focus on the common-law touchstone of control individuals with a disability, while smaller and its submission that the six common law factors businesses have traditionally remained exempt are relevant to the inquiry of whether a 7from ADA compliance. Thus, ADA compliance for shareholder-director is an employee. The Court smaller entities such as professional corporations found that since the doctors at the clinic, is often determined by how many individuals fit the "apparently control the operation of their clinic, ... definition of employee. In a recent case, the share the profits and ... are personally liable for Supreme Court addressed ADA compliance and malpractice claims," they should not be regarded whether it affects small medical practices, many of as employees. which are structured as professional corporations. The implications of this case are wide-ranging, This issue was recently addressed by the United given the number of small professional States Supreme Court in the case Clackamas 8corporations across the United States. The Gastroenterology Associates, P.C. v. Wells. After Supreme Court's ruling has, on the one hand, set experiencing mixed connective tissue disorder and standards that small professional corporations can taking some time off from work, Debra Wells was use to determine whether or not they are subject to fired in 1997 when she failed to return to work at a the ADA and, on the other hand, some set time. She had been employed as a professional corporations, such as a small medical bookkeeper for 11 years by Clackamas clinic, that thought they were ADA exempt, could Gastroenterology Associates, a professional medical corporation incorporated in Oregon, which 7 The six factors used to determine whether an employed 16 to 19 people, 4 of whom were individual is an employee under common law are (1) physician-shareholders. Debra Wells sued whether the organization can hire or fire the individual Clackamas Gastroenterology Associates for or sets the rules and regulations of the individual's work; unlawful discrimination under the ADA. (2) whether and, if so, to what extent the organization supervises the individual's work; (3) whether the The Court had to decide whether the four doctors individual reports to someone higher in the organization; could be considered employees. If they were (4) whether and, if so, to what extent the individual is considered employees, then Clackamas able to influence the organization; (5) whether the parties intended that the individual be an employee, as Gastroenterology Associates would have enough

    expressed in written agreements or contracts; and (6) employees to make it subject to the ADA. The whether the individual shares in the profits, losses, and United States District Court for the District of liabilities of the organization. Oregon found that the four doctors were more 8 This decision could also affect other laws in which 6coverage under the law is determined by number of Jill Santomero is EFM's 2003 Summer Associate. Jill

    employees (including the Age Discrimination in comes to us from Villanova University School of Law,

    Employment Act, Title VII, the Family and Medical where she will be starting her third and final year this

    Leave Act, and certain state laws). Fall.

    Two Commerce Square find themselves subject to the ADA because their 2001 Market Street, Suite 3410 doctors are considered employees. Philadelphia Pennsylvania 19103 The determination of whether or not a professional 215. 751.9666 (p) - 215.751.9310 (f)

    *** corporation, such as a small medical practice, is

    2021 New Road exempt from the ADA and other federal anti-Two Linwood Professional Plaza discrimination laws could depend on how that Linwood, New Jersey 08221 medical practice is structured, including the 609.601.6030 (p) - 609.601.6050 (f) amount of control the practice has over individual *** physicians, whether physicians are referred to as 601 Thirteenth Street NW, Suite 390S employees (e.g. in an employment agreement), Washington, D.C. 20005 and how the physicians’ compensation is 202.347.1917 (p) 202.347.8344 (f) structured. _______________________ The Cutting Edge Team: Copyrighted by Eizen Fineburg & McCarthy, P.C.

    Bernard Eizen, Herbert R. Fineburg, This publication is intended for general information

    purposes only. It does not constitute legal advice. The Gary J. McCarthy, Robert F. Kelly, reader should consult with knowledgeable legal counsel Paul J. Cianci, A. Steven Fabietti, Ted M. Greenberg, to determine how applicable laws apply to specific facts Erica A. Intzekostas, Glenn R. Weiser, Marvin Weiss and situations.

    Articles in the publication are based on the most

    current information available at the time they were

    written. Since it is possible that the laws or other circumstances may have changed since publication EFM: The Cutting Edge please call us to discuss any action you may be Examining the latest trends considering as a result of reading an article. in the law. . .

    Eizen Fineburg & McCarthy, P.C.

Eizen Fineburg & McCarthy, P.C.

    Two Commerce Square

    2001 Market Street, Suite 3410

    Philadelphia, PA 19103

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