TROUBLE BREWING; ESTATE TAX IN MD, DC AND VA

By: Jennifer Concino of Tobin, O'Connor, Ewing & Richard

With the average cost of a house rapidly rising in the DC Metropolitan area, it is especially important that homeowners recognize the need for tax and estate planning. Each and every homeowner should make sure that he has planned for his certain and eventual demise. For example, the estate of a resident of the District of Columbia with equity in a house of $1,500,000 could pay $64,400 in estate taxes to the District. Proper estate planning could help the homeowner defer, reduce or even potentially eliminate the tax.

The Federal Situation:
As you may already be aware, in 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) which, among other things, increased the federal estate tax applicable exclusion amount as follows:

Year -- APPLICABLE EXCLUSION AMOUNT
2006-2008 -- $2,000,000
2009 -- $3,500,000

EGTRRA eliminated the federal estate tax for individuals dying on or after January 1, 2010. However, unless between now and then, Congress and the President extend the law beyond December 31, 2010, or provide alternative tax relief, the estate tax as is existed in 2001, i.e. only a $1,000,000 applicable exclusion amount per person, will be reinstated on January 1, 2011, including a marginal rate of 55 percent.

Many of the documents drafted for our clients in the past include the establishment of a "by-pass trust" the funding of which is determined by a formula providing that the largest amount that can pass free of federal estate tax (the applicable exclusion amount) will fund such by-pass trust. By "forcing" the funding of a by-pass trust, each spouse is assured of utilizing his or her applicable exclusion amount thereby enabling each family to pass the largest amount possible of their estate to the next generation free of estate tax.

The States React:
Many states, facing deficits and losses in revenue as a result of EGTRRA, have taken action to prevent a similar increase in their exemption amounts for state death tax purposes. As such, the issue of "decoupling" has arisen. For example, even though the federal applicable exclusion amount is $2,000,000 this year, the State of Maryland and the District of Columbia have capped their exclusion amounts at $1,000,000.

Virginia has repealed its estate tax for individuals dying on or after July 1, 2007. Since many clients' estate planning documents include the forced by-pass trust formula, $2,000,000 (the federal applicable exclusion amount) would pass to the by-pass trust upon the death of the first spouse. This would result in no federal estate tax at the time of the first spouse's death, however, there would be a tax on the excess $1,000,000 in Maryland and the District of Columbia. The amount of that state death tax is pretty hefty; in 2007, the tax may be almost $85,000. For a death which occurs in 2009, where the federal applicable exclusion amount of $3,500,000 would pass to the by-pass trust (and Maryland and the District of Columbia continued to cap their exclusion amounts at $1,000,000) the state estate tax could be over a whopping $225,000! Maryland has, however, capped its estate tax to 16 percent of amounts over the $1,000,000 exclusion amount.

Our Response:
The current differences between the federal and state death taxes, as well as the differences among the local jurisdictions, require a case-by-case analysis for each client. For example, in some instances, it will be preferable to pay the state death tax assessed at the time of the first spouse's death by fully funding the by-pass trust with the federal applicable exclusion amount. Although this will accelerate the payment of state death taxes, the excess amount funded into the by-pass trust (i.e., $1,000,000 in 2007), including all appreciation thereon, will then be excluded from the surviving spouse's estate, thereby potentially sheltering significant wealth and saving federal tax at the top marginal estate tax rate which is 46 percent in 2007.

However, many clients may prefer to avoid the payment of state estate taxes upon the death of the first spouse and in such cases, it may be necessary to prepare new wills/revocable trusts. These new documents can provide that the by-pass trust will be funded with the lesser of the federal or state exclusion amounts. Another option provides that the entire estate would pass to the surviving spouse, subject, however, to the surviving spouse having a power to "disclaim" a portion of the bequest into the by-pass trust. This option would allow maximum flexibility on a post-mortem basis to the ever evolving estate tax landscape. Alternatively, the entire estate of the first spouse to die may be paid over to a marital trust for the benefit of the surviving spouse. In such case, the personal representative may determine after the death of the first spouse not to elect "marital deduction" treatment for any portion of the marital trust (the state estate tax exclusion amount or the federal estate tax exclusion amount).

Make an Appointment:
We recommend that each of our clients have their existing estate planning documents reviewed as soon as possible. Please contact us (202-362-5900) to arrange a time to discuss your documents and what changes, if any, are appropriate for your needs.

FIRPTA - How to protect your buyer

By: Joseph Gentile

What is FIRPTA?
The Foreign Investment in Real Property Tax Act (FIRPTA), 26 U.S.C. § 1445, provides that a buyer must withhold 10 percent of the amount realized by the foreign seller in the sale of an interest in U.S. real property. If the seller is a foreign person and the buyer fails to withhold, the buyer may be held liable for the tax.

My seller is a resident alien, does that mean FIRPTA applies?
A resident alien, for purposes of FIRPTA, is not a foreign person. FIRPTA defines a foreign seller as a non-resident alien individual, a foreign corporation not treated as a domestic corporation, or a foreign partnership, trust or estate. There are two ways to determine if a person qualifies as a resident alien under FIRPTA: 1) if a person has been issued an alien registration card ("green card") or 2) the substantial presence test that requires a person be physically present in the United States for a certain number of days a year. 183 days (pursuant to IRS Code).

My seller does not have a green card. What qualifies under the substantial presence test?
The short answer is that if your seller was physically present in the United States for at least 183 days in the previous calendar year, he or she qualifies as a resident alien and is not subject to FIRPTA withholding. Even if the seller does not meet this requirement, he or she might still be exempt from FIRPTA, by using the complicated formula found in IRS Code § 7701 that states that a seller qualifies as a resident alien if:

* the seller was present in the United States on at least 31 days during the calendar year, and
* (the number of days present in current year) + (the number of days present in preceding year x 1/3) + (the number of days present in 2nd preceding year x 1/6) equals or is greater than 183.

How do you determine the amount realized for FIRPTA?
The amount realized typically is the sales or contract price. Please note that the outstanding amount of any liability assumed by the buyer does not reduce the amount realized. If the property is owned jointly by foreign and non-foreign persons, the amount realized is to be allocated among the owner based on capital contributions, with spouses treated as having contributed 50% each. Generally, the amount to withhold is 10% of the amount realized, unless the seller is a corporation, partnership, trust, or estate in which case the amount may be 35%.

I am buying a house from a foreign person as defined by FIRPTA, what do I need to do now?
The buyer must use IRS Forms 8288 (www.irs.gov/pub/irs-pdf/f8288.pdf) and 8288-A (www.irs.gov/pub/irs-pdf/f8288a.pdf) to report and pay to the IRS any tax withheld on the purchase of U.S. real property interests. Generally, these forms need to filed with the IRS within 20 days of the date of transfer, defined as the date consideration is first paid, excluding earnest money or deposits. Failure of the buyer to withhold the proper amount may cause the buyer to be liable for the payment of the tax plus penalties and interest as well as possibly making the buyer subject to criminal penalties.

Even though the seller is a foreign national, are there any exceptions to the withholding?
Several exceptions do apply and exempt the buyer from withholding. Here is a partial list of the most common exceptions in a real property transfer:

* The property is purchased for $300,000.00 or less and is to be used by the buyer as his or her residence. The test for a residence is if the buyer is to reside in the property for at least 50% of the days in the next two 12 month periods.
* The seller provides to the buyer a Non-Foreign Status Certification containing the transferor's U.S. taxpayer identification number and stating that the transferor is not a foreign person. The buyer need not investigate the validity of the certification, but will be held liable if he or she has actual knowledge that it is false.
* The seller provides to the buyer a withholding certificate from the IRS that excuses or lowers the withholding amount.
* No consideration is paid (for example the property was transferred as a gift).
* An option to acquire real property is signed (however, withholding is required on the sale when the option is exercised).
* The purchaser is the United States, a U.S. state or possession or political subdivision, or the District of Columbia.
* The seller provides a notice signed under penalties of perjury stating that the seller is not required to recognize gain or loss on the transfer because of a nonrecognition provision of the Internal Revenue Code or a provision in a U.S. tax treaty.

Where can I get more information on FIRPTA?
We would be glad to answer any questions that you might have on FIRPTA, but additional information, applicable forms, the withholding certificate application process, and more, can be found at www.irs.gov.