The following summarizes recent estate planning developments.


The Ninth Circuit Federal Court of Appeals, which has jurisdiction over California, decided an important family limited partnership case titled Estate of Virginia A. Bigelow.1 In Bigelow the Court found that the decedent made an “implied agreement” to retain the economic benefits of the assets which she transferred to a family limited partnership because the partnership was not properly operated and the partnership paid the decedent’s debts. Accordingly, in Bigelow all of the partnership’s assets were brought back into the decedent’s gross taxable estate under Internal Revenue Code Section 2036. Similarly, in Estate of Concetta H. Rector 2Section 2036 applied where the family partnership paid the decedent’s personal expenses and taxes, the decedent controlled the partnership, and substantially all of the decedent’s wealth was transferred to the partnership. The Bigelow and Rector cases highlight the importance of properly operating and funding a family partnership, not using the partnership’s assets for personal use, and not transferring substantially all of a client’s assets to the partnership.3

California limited partnerships formed after January 1, 2008 can take advantage of the new California Uniform Limited Partnership Act which provides that limited partners no longer have a statutory right to remove the general partner, although the partnership agreement can give the limited partners such a right (this new law can result in larger valuation discounts as an applicable restriction under Section 2704(b)).4

Clients with currently established family partnerships may wish to consult with us as to how to properly operate these partnerships, and whether their particular family partnership agreement needs to be updated to comply with the most recent court decisions.


When closely held corporate stock is valued for estate and gift tax purposes, the estate is entitled to a valuation discount if such stock represents a minority interest, as well as a valuation discount for that stock’s lack of marketability. An additional valuation discount for C corporation stock is for the proportionate amount of the built-in corporate income tax liability. The Jelke5case held that the value of the corporation is to be discounted by a 100% dollar-for-dollar amount for contingent future built-in corporate tax liabilities in a hypothetical corporate liquidation. Under the Jelke valuation principles it is assumed that the corporation liquidates and pays the corporate tax liability on the decedent’s date of death, regardless of whether or not the corporation actually intended to liquidate.6

The ability to deduct as a corporate liability 100% of potential future corporate taxes on a hypothetical corporate liquidation increases stock valuation discounts, which in turn enhances the ability to transfer corporate stock tax free from parents to children and grandchildren.


Currently taxpayers under Internal Revenue Code Section 6166 may pay estate taxes in ten equal annual installments as to that portion of the gross estate which represents a “closely held business,” if certain conditions are met. One condition is that the closely held business must comprise more than 35% of the decedent’s adjusted gross estate. The first annual estate tax installment must be paid by the fifth anniversary of the due date of the estate tax liability. What is a “closely held business” for purposes of paying estate taxes in installments has been liberally defined by the Internal Revenue Service for rental real estate.7

Additionally, for decedents dying in 2007 the installment payment of estate taxes is subject to a favorable low interest rate of two percent on the first $1,250,000 of value of the closely held business (for decedents dying in 2008 this “two percent portion” is increased to $1,280,000); with the remainder of the deferred estate taxes on the closely held business bearing interest at only 45% of the regular underpayment rate.

In a 2007 Tax Court case8 the Court stated that the Internal Revenue Service cannot require the taxpayer to post a bond or special lien for every estate which elects to pay its estate taxes in installments. Rather, the Internal Revenue Service must consider that taxpayer’s specific facts and circumstances before the Internal Revenue Service can require a bond or special lien from that taxpayer.

If a client owns a closely held business or active real estate, then that client may wish to review the ownership structure to qualify for favorable estate tax installment payment treatment.


Currently California has no inheritance tax and no state-imposed estate tax. The Federal estate tax in 2008 provides for a $1,000,000 gift tax exclusion and a $2,000,000 estate tax exclusion per person, and a maximum transfer tax rate of 45 percent. 9 The estate tax exclusion increases to $3,500,000 in 2009. The entire Federal estate tax is scheduled to be repealed for the 2010 tax year (however, for the 2010 year the maximum gift tax rate will be 35% and there is a carryover income tax basis for persons dying in 2010). Under current law, the estate and gift tax will be restored in 2011 to a 55% maximum estate tax rate with a $1,000,000 aggregate estate tax and gift tax exclusion.10

Although during 2007 several tax proposals were considered by Congress to modify the Federal estate and gift tax, to date no new tax legislation has been enacted.11 Many political observers feel that estate tax reform will only be addressed after the 2008 Presidential election (meaning sometime during 2009 or even in 2010). We are, thus, left with the uncertainty of changing estate tax rates and exclusions. Clients should incorporate into their estate plan documents provisions to take into account the changing estate tax rates and exclusion amounts, and provide for flexibility (such as through the use of disclaimers and special trustee provisions with powers to modify the trust).


For 2007 and 2008 the annual gift tax exclusion, which represents the amount that each person can give gift tax free to a donee per year, is $12,000 ($24,000 per donee combined for husband and wife). Thus, for example, a husband and wife with three children and eight grandchildren (for a total of 11 potential donees) could give $264,000 per year gift tax free ($24,000 for husband and wife multiplied times 11), which is in addition to the current $1,000,000 gift tax exclusion which each of husband and wife can utilize. Additionally, clients can continue to pay directly gift tax free an unlimited amount for their children’s and grandchildren’s medical expenses and school tuition.


Currently California taxpayers who purchase tax-free municipal bonds issued by states other than California must pay a California income tax on these out-of-state bonds’ interest. On the other hand, California taxpayers do not pay California state income tax on their California tax-free municipal bonds’ interest.

The United States Supreme Court in the case of Davis v. State of Kentucky12will decide whether states can legally tax other states’ municipal bond interest in a manner different than their own state’s bond interest. If the Supreme Court decides in favor of the taxpayer, then California taxpayers would be able to purchase out-of-state municipal bonds and have those bonds’ interest not taxed by the State of California. Alternatively, if the taxpayer wins the Davis case, California could enact tax laws to tax both California’s and other states’ bonds’ interest in the same manner. Some financial observers predict that if the Supreme Court decides Davis in favor of the taxpayer (and against the State of Kentucky), that there may be a negative impact on the value of long-term California municipal bonds because of a reduced demand for such bonds from California taxpayers since California taxpayers would be able to purchase other states’ bonds and receive the same tax treatment.

Clients with large positions in tax-free California municipal bonds should speak with their bond broker and financial advisor as to the potential effect that the Davis case will have on their own bond portfolio. Also, clients should consider filing with the State of California protective tax refund claims for income taxes which these clients previously paid on out-of-state municipal bond interest.


The general income tax rule is that miscellaneous itemized deductions are allowed only to the extent that they exceed two percent of adjusted gross income under Internal Revenue Code Section 67. Section 67(e) contains an exception providing that estates or trusts may deduct fees for administration which would not have been incurred if the property were not held in such trust or estate. In other words, the two percent floor does not apply if the Section 67(e) exception applies.

The United States Supreme Court is now set to decide in the case of Knight v. Commissioner 13 whether this Section 67(e) exception applies to financial advisory fees incurred by trusts and estates.

Proposed Regulations14 were issued in July 2007 in an effort to define the applicability of the Section 67(e) exception to the two percent floor rule. These Proposed Regulations separate from trustees’ fees that portion which is an investment advisory fee (which is not eligible for the two percent floor exception) from that portion which is in fact eligible for the Section 67(e) exception. For example, these Proposed Regulations indicate that the Section 67(e) exception applies to that portion of the trustee fee which involves the preparation of fiduciary accountings, the preparation of the fiduciary income tax and estate tax returns, communications with trust and estate beneficiaries on trust and estate matters, and the determination of sprinkling distributions to trust beneficiaries. These Proposed Regulations will not be effective until they are finalized, and the IRS will undoubtedly finalize these Regulations only after the United States Supreme Court renders its decision in the Knight case.


Effective January 1, 2009 persons who are trustees under trusts for the benefit of more than three persons or more than three families will have to register with the State of California, meet certain educational and other criteria, and pay a fee. 15 These rules do not apply to attorneys, certified public accountants, and persons who are enrolled as agents to practice before the Internal Revenue Service. There is an exception for individuals who serve as trustees for members of their own family.

Accordingly, clients and other persons who serve as trustees of trusts for non-family members and who do not fall within the law’s listed exceptions, should be alerted to these new licensing requirements. To administer these new trustee licensing rules, California established the Professional Fiduciaries Bureau which is under the Department of Consumer Affairs.

  1. Estate of Virginia A. Bigelow, 100 AFTR 2d, 2007-6016 (9th Cir. 2007).
  2. Estate of Concetta H. Rector, T.C. Memo 2007-367.
  3. Two similar 2007 Tax Court cases which taxpayers lost because the family partnership was not correctly formed or was not properly operated are Estate of Sylvia Gore, T.C. Memo 2007-169; and Estate of Hilde Erickson, T.C. Memo 2007-107.
  4. See the new California Uniform Limited Partnership Act of 2008, at California Corporations Code ‘ 15900 et. seq.
  5. Jelke, 100 AFTR 2d, 2007-5475 (11th Cir. 2007). The Jelke case followed Estate of Dunn, 90 AFTR 2d, 2002-57 (5th Cir. 2002), and rejected the Tax Court’s position that only the present value of the potential corporate tax liability should be utilized based upon when that corporation’s assets are likely to be sold and the tax liability incurred.
  6. This Jelke valuation theory is consistent with Statement of Financial Accounting Standards No. 109 which states that in accounting for deferred income tax liabilities it is impractical to determine deferred tax liabilities on a “present value” basis. Under this accounting standard the measurement of current tax liabilities does not take into account possible future tax rate changes.
  7. See Revenue Ruling 2006-34 in which the IRS listed the following factors to determine if real estate is a “closely held business” qualifying for estate tax installment payment treatment: (i) the amount of time devoted to the real property; (ii) whether the client maintains a real estate office during regular business hours; (iii) the client’s involvement in finding new tenants and negotiating leases; (iv) the client’s providing of services to the real property, such as landscaping; (v) the client’s involvement in making repairs and doing maintenance of the real property; and (vi) the client’s processing of tenants’ repair requests and tenants’ complaints.
  8. See Estate of Edward P. Roski, 128 T.C. 113 (2007). IRS Notice 2007-90 announced that the IRS would follow the Roski case and outlined those factors and circumstances where the IRS would require a lien or bond for installment estate tax payments. This important development allows more estates to pay estate taxes in installments without having to post a bond or grant the IRS a lien on business assets.
  9. The generation-skipping transfer tax exemption is $2,000,000 in 2008, and will increase to $3,500,000 in 2009.
  10. These changing tax rules were enacted as part of the Economic Growth and Tax Relief Reconciliation Act of 2001.
  11. Also, Congressional tax committee staffs have discussed possible new tax legislation to impose limitations on the use of trusts for lifetime gifts, and to eliminate valuation discounts for closely held corporate stock and partnership interests where the same family controls the entity.
  12. See United States Supreme Court Docket No. 06-666. This case was argued before the Supreme Court on November 5, 2007.
  13. Knight v. Commissioner, United States Supreme Court docket number 06-1286, argued before the Supreme Court on November 27, 2007.
  14. These Proposed Regulations which were released July 16, 2007 have been criticized by representatives of the American Institute of Certified Public Accountants.
  15. See the California Professional Fiduciaries Act at ‘ 6500 et. seq. of the California Business and Professions Code. This fiduciary licensing requirement commences January 1, 2009. However, a person appointed by the Court as a “professional fiduciary” after July 1, 2008 must be validly licensed.