MCFERRAN LAW: UPDATE ON THE NEW RULES FROM CONGRESS - GIFT AND ESTATE TAX EXCLUSIONS

Last edition we looked at and focused on the many changes in the tax law affecting mostly individual and business taxpayer matters. We did not talk at all about certain changes brought about by the American Taxpayer Relief Act of 2012 as well as Public Law 115-97, known as the "Tax Cuts and Jobs Act", which became law on December 22, 2017 affecting gift and estate taxes at the federal level.

I am attuned to these estate planning tax rules as they are a part of our class on estate planning. Recently many calls have been coming to our office as many of our clients are not really grasping the real AND SUBSTANTIAL impact of the recent changes in the tax law about gift and estate taxes.

Maybe by looking at the past history of this type of tax and by studying a detailed graph, we can shed some better light to our readers on this massive change affecting estate.

Background and History of Gift and Estate Taxes in Our Country

I am not going to give a complete detailed history of estate and gift taxes at the federal level in this short writing. Suffice it to say that we as citizens of the United States have traditionally been taxed on our gifts both during our life and the value of our estate at our death when such aggregated values exceed a certain dollar threshold.

A graph is worth a thousand words and I thank the underwriters at Stewart Title for compiling the graph below for which I give them credit and I humbly reprint here for your reference.

If you review it closely you will see that thresholds in years gone by were as low as $650,000.00 for an individual estate and that would affect many (if not most) of our readers. It was increased to $1,000,000 for a couple years, but still affected many. It gradually increased from there. Let’s look to see what happened recently. If you look closely, you will see that the threshold has really been raised to $11,200,00.00 for an individual basically eliminating estate taxes for about 98% of the citizens in the country.

Summary of Federal Estate Tax Exclusions and Maximum Rates over the Years

(Courtesy of Stewart Title)

The following is a summary of Federal estate tax basic exclusions and maximum rates per person: 

Tax Year	Estate Tax Basic Exclusion	Maximum Estate Tax Rate
1997	$600,000	55%
1998	$625,000	55%
1999	$650,000	55%
2000	$675,000	55%
2001	$675,000	55%
2002	$1,000,000	50%
2003	$1,000,000	49%
2004	$1,500,000	48%
2005	$1,500,000	47%
2006	$2,000,000	46%
2007	$2,000,000	45%
2008	$2,000,000	45%
2009	$3,500,000	45%
2010	$5,000,000 or Zero *	35% or Zero *
2011	$5,000,000	35%
2012	$5,120,000	35%
2013	$5,250,000	40%
2014	$5,340,000	40%
2015	$5,430,000	40%
2016	$5,450,000	40%
2017	$5,490,000	40%
2018	$11,200,000 **	40%

* The 2010 Tax Act gave estates of decedents dying in 2010 the option to choose between the revived estate tax and the prior (EGTRRA) tax law. These estates have the option to elect either: (1) the new estate tax, based upon the new 35% maximum rate and the $5 million exclusion, with a stepped-up basis for property in the estate, or (2) no estate tax, and the required application of modified carryover basis rules under EGTRRA.

** Prior to the enactment of the Tax Cuts and Jobs Act, this amount had been scheduled to increase to $5,600,000 in 2018.  

The Tax Cuts and Jobs Act increased the basic exclusion amount in the case of estates of decedents dying after December 31, 2017, and before January 1, 2026, by substituting '$10,000,000' for '$5,000,000' in the law. The $10,000,000 amount is indexed for inflation after 2011.

Spousal Portability

The 2010 Tax Act provided for the "portability" of the Federal estate tax exclusion between spouses. Portability permits spouses to aggregate each spouse's Federal estate tax exclusion.

A surviving spouse may elect to add the unused portion of a deceased spouse's estate tax exclusion (the "Deceased Spousal Unused Exclusion") to the surviving spouse's estate tax exclusion, thereby providing the surviving spouse's estate with a larger applicable exclusion amount.

Portability is available only to estates of decedents where both spouses died after December 31, 2010, and only if an election is made on a timely filed estate tax return of the predeceased spouse. Under the 2010 Tax Act, the portability provision was set to expire on December 31, 2012.

The more recently passed American Taxpayer Relief Act made spousal portability of the Deceased Spousal Unused Exclusion permanent. 

The Tax Cuts and Jobs Act just passed and law today did not modify the Spousal Portability rules. Therefore, in 2018, the combined potential exclusion amount per couple is $22,400,000.  This is exciting.

State of Washington Death Tax [Washington does not have a Gift Tax]

Prior to January 1, 2005, a credit was allowed against the Federal estate tax for any state death, estate or inheritance taxes paid to any state or the District of Columbia. 

Beginning on January 1, 2005, EGTRRA replaced the state death tax credit with a deduction for death taxes paid to any state or the District of Columbia. The deduction was set to expire on December 31, 2010. The 2010 Tax Act extended the deduction for actual state estate taxes paid until December 31, 2012.

The more recently passed American Taxpayer Relief Act made the deduction for state estate taxes permanent.

Keep in mind that although the thresholds are much higher at the Federal level, the threshold at the State of Washington level is currently slightly over $2,000,000.00 and is adjusted yearly for inflation. The actual amount for 2018 is $2,129,000.00 as adjusted for inflation.

Implications for Federal Estate Tax Returns

Due to the increased Federal exclusion amount, fewer estates will be subject to Federal estate tax and a potentially larger number of estates will not be required to file a Federal estate tax return: Form 706: United States Estate (and Generation-Skipping Transfer) Tax Return.

However, any estate valued at more than the basic exclusion amount for the year of death must file a Federal estate tax return even if no Federal estate tax will be owed after applicable exclusions and deductions are applied. Any estate applying to make use of a Deceased Spousal Unused Exclusion must also file an estate tax return.

There are always risks inherent in real estate transactions. To guard against these risks, real estate purchase and sale agreements typically include contingencies, including an important inspection contingency.

Additionally, when dealing with newly constructed property, a buyer will generally expect that all work would be done in a workmanlike manner. However, as illustrated in the case below, the devil is in the details, and Buyers should always be aware of the specific terms of the Purchase and Sale Agreement and Buyers should always seek to take advantage of inspection contingencies.

In Schumacher v. T. Garrett Construction, Inc., 199 Wn. App. (2017), Division Two (in Tacoma) of Washington’s Court of Appeals was faced with a post-closing dispute arising from a Real Estate Purchase and Sale Agreement of a newly constructed property.

FACTS OF THE DISPUTE BETWEEN BUYER AND SELLER

*****In that case, the Buyers and Sellers entered into a Purchase and Sale Agreement for a property which was then under construction.

*****The Purchase and Sale Agreement included an inspection addendum and an addendum in which the buyer’s requested certain builder specifications.

*****During the transaction, the Buyer and Seller communicated regularly and met informally at the property several times to discuss the scope of the project.

*****Additionally before closing, the Buyer and Seller had a formal walk-through in which the Buyer made certain requests of the Seller to make repairs to which the Seller responded to those requests and made repairs that satisfied the Buyer prior to the date of closing.

*****However, at no point did the Buyer have the property inspected by a third-party home inspector even though such was provided as an inspection contingency within the Purchase and Sale Agreement.

*****At closing, the Buyer complained to the Seller about issues with the property including issues with the kitchen cabinets and trim, and the exterior stone veneer of the garage which the Seller had installed before closing. However, the transaction was closed without these repairs being made.

*****After closing, the Buyers continued to complain to the Seller about many alleged defects with the property. The Seller offered to repair kitchen cabinetry, trim problems, and replace the stone on the exterior garage wall, but the Buyers’ reject this offer.

*****The Buyers filed a lawsuit against the Seller for breach of contract, breach of the implied warranties of habitability and fitness for a specific purpose, breach of limited warranty, and consumer protection act violations.

RULING AT THE TRIAL COURT LEVEL

At the trial court level, the Buyers prevailed on their breach of contract claim and obtain a judgment against the Seller for $9,772.50 NOT including attorney fees and costs!!!

The trial court based its damages award on the defective stone on the garage exterior ($5,500 plus $522.50 in sales tax), defective cabinets and trim in the kitchen ($350), and Seller's failure to build a cedar fence ($3,400).

The trial court found that the Buyers were the substantially prevailing party and awarded attorney fees and costs totaling $13,021.31.

The Seller being upset appealed.

RULING FROM THE COURT OF APPEALS

The Court of Appeals reversed the trial court.

The Court of Appeals held the trial court erred in awarding the Sellers damages for the improper installation of the garage stone and kitchen because recovery for the installation of these items was not recoverable under the Purchase and Sale Agreement and because there were no warranties or guarantees in the Purchase and Sale contract.

Further, the Court of Appeals held that the trial court erred in awarding the Seller’s damages for the cedar fence because the Purchase and Sale Agreement never referenced the fence and that, although the fence was advertised in a flyer, the flyer was never properly incorporated into the Parties’ Purchase and Sale Agreement.

Additionally, the Court of Appeals held the trial court erred in awarding the Buyer their attorney fees and costs.

To make matters worse for the Buyers, the Court of Appeals remanded the case back to the trial court to enter an award of attorney’s fees and costs in favor of the Seller at the trial court level and the Court of Appeals awarded the Seller its attorney’s fees and costs on appeal.

In making its ruling, the Court of Appeals noted that although new construction includes the implied warranty of habitability, this guarantees that a foundation supporting a house is firm and secure and that a house is structurally safe. However, this warranty does not apply to defects in workmanship absent a specific contractual term.

PRACTICE POINTER: The practice pointer here is to always make sure a client reviews (and understands) the terms of a Purchase and Sale Agreement before going under contract.

Further, when dealing with new construction, exercise caution in assuming there are warranties outside of the contract itself.

Additionally, although a buyer may be happy with informal inspections and may be looking to save money, if problems arise, not taking advantage of a formal third-party home inspection may limit a buyer’s rights to recovery after closing. When it comes to inspections, error on the side of caution.

PRACTICE POINTER: Many consumers are convinced that there exists a warranty in new construction. There are warranties all over the place. each appliance has a warranty. Many of the products used in the construction may have a warranty. However, there is no specific workmanship warranty in Washington UNLESS the contractor specifically provides one.

PRACTICE POINTER: We always encourage our client buyers to have a third-party licensed home inspection ESPECIALLY in new construction. I must talk long and hard as I get all kinds of resistance. However, these inspections have found a whole host of defects and repairs required even in new construction. Building Inspectors from the country or city miss a lot folks. Inspection dollars spent in new construction purchases will pay off handsomely in the long run especially as buyers understand their limited ability to recover against a builder after closing.