Wisconsin: An Estate Planning Paradise
Sunbelt states may be popular retirement destinations for us
snowbirds, but Wisconsin's estate planning advantages can make even
subzero wind chills seem like paradise.
By Andrew J. Willms and Dean T.
Wisconsin is well known for its
great vacation opportunities. It also can be an estate planning paradise
for Wisconsin citizens who benefit from a variety of advantageous laws.
This article describes various aspects of Wisconsin law that attorneys
should consider and emphasize to their estate planning clients who are
contemplating a change of domicile.
Wisconsin has no state inheritance tax
Most clients are surprised that Wisconsin no longer has an
inheritance tax. As of Jan. 1, 1992, Wisconsin replaced its inheritance
tax with an estate "pick up" tax that is limited to the credit allowed
for state death taxes under the federal estate tax system. 1 If a federal estate tax is imposed on the estate
of a deceased Wisconsinite, the state receives the amount of the credit
for state death taxes and the IRS receives the remainder. If there is no
federal estate tax to pay, then there also is no Wisconsin estate tax.
Thus, Wisconsin's estate tax results in no additional taxes.
Wisconsin does not recognize the common law rule against
The rule against perpetuities is an English law principle that has
been carried over to the United States. It requires a person's interest
in property to vest (or become absolute) within a certain period,
typically within a life or lives in being plus 21 years. When the rule
applies, restrictions placed on the transfer of property beyond that
period will be invalid.
The rule against perpetuities can be an obstacle in estate planning
in connection with trusts that are intended to continue for many
generations. These trusts (sometimes called "Dynasty Trusts") will not
be effective in states that still follow the old English law rule.
Wisconsin is one of only a few states that does not recognize the rule
against perpetuities in its common law form. Instead, Wisconsin statutes
provide for a rule against suspending a power of alienation that voids a
future interest or trust if it suspends the power of alienation for
longer than the "permissible period," which is set by statute as a life
or lives in being plus 30 years.2 The
statute also provides that a violation of the rule is avoided for trusts
if the trustee has the power to sell trust assets, or there is an
unlimited power to terminate the trust in one or more persons in being.
Therefore, a trust established in Wisconsin can continue indefinitely as
long as the grantor grants the trustee the power to sell trust
Wisconsin Marital Property law
In 1986 Wisconsin adopted the Marital Property Act, which essentially
changed Wisconsin from a common law property state to a marital property
state.3As complicated as the marital
property law can be, it provides the foundation for significant estate
planning benefits for Wisconsin residents.
Transferring assets at death: will substitute
agreements. The Wisconsin Marital Property Act provides that
married persons may agree that upon the death of either spouse, either
or both spouse's property, including any after-acquired property, may be
transferred without probate to a designated person, trust, or other
entity.4 As a result, a marital property
agreement that directs how a married person's assets are to be
distributed can protect those assets from probate, if the asset is
located in Wisconsin.
Perhaps the most effective way to use this type of provision
(sometimes called "Washington Will Provisions" because a more limited
version of the concept originated in Washington state) is to direct that
such assets be transferred to a living trust upon death. Wisconsin is
the only state that permits a living trust to be funded after
the grantor's death while still avoiding probate.5
However, will substitute provisions in a marital property agreement
often are not appropriate as the primary asset transfer document at
death. Section 766.58(3)(f) of the Wisconsin Statutes essentially
provides a mechanism for transferring legal title of an asset to those
persons named in the marital property agreement. Therefore, the statute
offers no procedure for postmortem tax or other planning that usually
occurs within the guidelines and protections of the probate process or a
trust. Furthermore, absent specific provisions in the agreement to allow
unilateral amendment by one spouse, the will substitute provisions may
be revoked only by mutual consent of both spouses in a subsequently
executed marital property agreement.6 This
raises potential gift tax issues.7 By using
the will substitute provisions as the primary asset transfer document at
death, planners inadvertently may be locking one spouse into a
nontestamentary disposition that cannot be changed unless the other
"Double step-up" in capital gains tax
basis. Under the Internal Revenue Code, the basis of property
received from a deceased person receives an adjustment in basis (called
a "step-up" if the value of the asset has increased from the date of
acquisition to the date of death) equal to the property's fair market
value at the date of death.8 When a married
person who is a resident of a common law state dies, assets titled in
the name of the decedent will receive a new basis, but the basis of
property belonging to the surviving spouse is not adjusted, and the
basis of property owned jointly between spouses only receives a step-up
in basis equal to one-half of the fair market value of the asset on the
date of the decedent's death.9
By comparison, in community property states all community property
receives a full adjustment equal to the value of the property on the
death date of either spouse.10 Since
marital property is treated as community property by the Internal
Revenue Code, all marital property receives a full step-up in basis upon
the death of either spouse.11 Furthermore,
Wisconsin statutes also provide this same "double step-up" result for
state tax purposes.12 Accordingly, marital
property can help a surviving spouse avoid both state and federal
capital gain taxes.
Unfortunately, this double step-up in basis is not automatic for
Wisconsinites by mere fact of residence; spousal assets actually must be
classified as marital property or survivorship marital property.
Wisconsin's marital property law took effect on Jan. 1, 1986.13 Property owned by a married couple prior to that
date is not necessarily classified as marital property.14Likewise, property owned prior to marriage or
received after marriage by gift or inheritance may not be treated as
marital property.15However, Wisconsin's
Marital Property Act allows married persons to reclassify all assets
titled in either spouse's name as marital property in a marital property
agreement.16 As a result, in many cases a
properly drafted estate plan will include a marital property agreement
classifying the assets of the married couple as marital property to
ensure the adjustment in basis on all marital property at the death of
the first spouse.17
Equalizing the spousal estates. Under the Internal
Revenue Code, every individual is entitled to an "Applicable Unified
Credit Amount" which can shelter a specified amount of assets from
federal transfer taxes for gifts during lifetime and transfers at
death.18This credit can shelter $650,000 of
assets in 1999, but is scheduled to increase to $1,000,000 of assets for
persons dying in 2006 and beyond.19 If a
married couple uses both spouse's unified credits, the amount protected
from federal transfer taxes can be effectively doubled. For example,
assume a married couple living in a common law state has a combined net
worth of $1.25 million. Assume further that $1 million of these assets
are held in the husband's name. The remaining assets are held in both
spouse's names as tenants by the entirety. If the wife dies first, then
the assets held in the husband's name will not be available to fund the
wife's unified credit. Likewise, the joint assets will pass outright to
the husband by right of survivorship. As a result, the wife's unified
credit will not be used. Instead, all of the assets will be includable
in the husband's estate for federal estate tax purposes at his
death.20 In comparison, if the couple lived
in Wisconsin and had executed a marital property agreement that
classifies all of their assets as marital property, then half of the
assets held in the husband's name would be includable in the wife's
estate for federal estate tax purposes. As a result, those assets could
be used to fund the wife's applicable unified credit amount.
Often, a significant portion of a married person's assets will have
been accumulated inside an employer-sponsored qualified retirement plan.
Even though the assets inside such retirement plans may be classified as
marital property and owned equally by the spouses, federal law under ERISA21, which preempts state law, may prohibit a
married couple from using a surviving spouse's retirement benefits to
fund a deceased spouse's unified credit. 22
As a result, if one spouse has significantly greater qualified
retirement benefits than the other, it may be preferable in the marital
property agreement to classify some nonretirement plan assets (such as
the couple's home) as the individual property of the spouse who has
fewer retirement benefits in order to promote estate equalization.
Qualifying for the Family-owned Business Deduction.
Newly created I.R.C. section 2057 provides estate tax relief for
"qualified family-owned business interests" (Qualified Interests). If
the deduction applies, the estate tax liability is calculated as if the
estate were allowed a maximum family-owned business deduction of
$675,000 and a unified credit exemption equivalent of $625,000
regardless of the year in which the individual dies. For a decedent's
estate to be eligible for the deduction, the amount of the qualified
interests transferred by the decedent's death to "qualified
heirs,"23 both during life and at death,
must be greater than 50 percent of the decedent's gross estate.24
Wisconsin's Marital Property Act can be very helpful to ensure that a
married couple receives the maximum tax savings possible from the
family-owned business deduction. If the owner of a qualified interest is
married, and the qualified interest is classified as marital property,
then both estates are potentially eligible for the family-owned business
exclusion. By the same token, however, if both spouses own one-half of
the qualified interest because the qualified interest is classified as
marital property, it may be more difficult for either spouse's estate to
satisfy the requirement that the adjusted value of the qualified
interest included in a decedent spouse's estate (plus qualified interest
gifted by the decedent during life to family members) exceed 50 percent
of the decedent's adjusted gross estate.
Therefore, the classification of family-owned business interests
should be considered carefully. If the value of the couple's marital
property interest in the family-owned business is worth greater than 50
percent of the sum of the couple's interest in all marital property
assets plus each spouse's interest in individual property, then consider
classifying the family-owned business as marital property so that both
estates will be potentially eligible for the family-owned business
exclusion. If the foregoing is not true, then consider classifying part
or all of the family-owned business as the individual property of one of
Valuation discounts for
marital property. The federal transfer tax is imposed on the
fair market value of assets that are transferred either during life or
at death for less than full or adequate consideration (that is, on gifts
and inheritances). When determining fair market value, a willing
buyer/willing seller test is used.26That
is, in a sale between unrelated parties, what would be the sale price
for the interest being transferred?
Applying the willing buyer/willing seller test to a partial interest
in property can result in a significant discount in the value of that
interest for federal estate and gift tax purposes. As a result, if a
married person dies owning a partial interest in an asset, the value of
the deceased spouse's interest should be reduced for federal estate tax
purposes. For example, the U.S. Court of Appeals for the Fifth Circuit
approved a 45 percent discount for estate tax purposes when valuing the
husband's portion of properties that were owned jointly by the decedent
husband and a marital trust that had been created for his benefit upon
his wife's earlier death.27
Applying this rationale to marital property can mean big estate tax
savings for Wisconsin residents. Since marital property is considered to
be owned equally between husband and wife, one-half of marital property
is transferred at each spouse's death.28 As
a result, the value of most or all of the assets that belong to a
married or widowed Wisconsin resident may be eligible for discounts when
determining the amount of federal estate taxes that are payable.29
Estate planning with FLPs and LLCs
In community property states all community property receives
a full adjustment equal to the value of the property on the death date
of either spouse.
Because the willing buyer/willing seller test can result in
significant valuation discounts for federal estate and gift tax
purposes, Family Limited Partnerships (FLPs) and Limited Liability
Companies (LLCs) have become increasingly important tools when
developing estate plans for affluent individuals.30When FLPs or LLCs are used in connection with
estate planning, senior family members contribute assets to the entity.
Limited interests in the FLP or LLC are then gifted to children or other
family members. Giving limited interests in the FLP or LLC generally
removes the asset from the donor's estate for federal estate tax
purposes, while the donor can continue to maintain control of the
property. If properly structured, the value of FLP or LLC interests that
a donor gives to family members can be discounted significantly for gift
tax purposes to reflect: 1) a lack of marketability for those
interests31, 2) the inability of a limited
partner or member to control the FLP or LLC investments and
distributions32, and 3) restrictions that
may be contained in the FLP or LLC agreement on the ability to transfer
the limited interests.33
Dean T. Stange (top), U.W. 1993, practices with Neider
& Boucher S.C., Madison. Andrew J. Willms (bottom),
University of Miami 1984, is the sole shareholder of Willms Anderson
Restrictions contained in FLP or LLC agreements are disregarded by
the IRS for valuation purposes if they are more restrictive than state
law.34 For example, if state law allows a
limited partner or member to withdraw easily from an FLP or LLC,
regardless of the agreement terms, the IRS will not readily accept
valuation discounts for those interests since the membership units can
be converted to cash at the option of the limited partner or LLC member.
In addition, the IRS may be able to disregard restrictions imposed by an
agreement that is more restrictive than state law.35 Wisconsin's partnership law and limited
liability law both impose restrictions regarding the transferability of
FLP and LLC interests and do not allow a limited partner or member to
withdraw easily from the entity.21 As a
result, it should be more difficult for the IRS to challenge valuation
discounts claimed in connection with FLPs and LLCs established in
Wisconsin as compared to many other states.
Wisconsin residents often flock to warmer climates when they retire.
Many think that by moving they will not only enjoy warmer weather, but a
better estate planning climate. However, Wisconsin is hard to beat when
it comes to state laws that benefit estate planning.
2See Wis. Stat.
3The Wisconsin Legislature adopted
1983 Wisconsin Act 186, known as the "Wisconsin Marital Property Act,"
in April 1984. It became effective on Jan. 1, 1986.
5Washington and Idaho provisions
are limited to transfer of assets between spouses only. Section
867.046(1m) of the Wisconsin Statutes allows for the court to issue
a certificate confirming the transfer of the property interest under
6 Wis. Stat.
7The inability of a spouse to
unilaterally amend the disposition of property at death may be analogous
to the use of joint and mutual wills, which has been held to incur gift
tax liability under I.R.C. section 2501. See Estate of
Jessie L. Grimes v. Comm., 851 F.2d 1005 (7th Cir., 1988).
§ 1014(a). Date of death valuation or alternate value under
section 2032. Under I.R.C. section
1014(c), the basis adjustment rule applies to capital appreciation
only. There is no basis adjustment for items considered income in
respect of a decedent.
§§ 1014(a), 1014(b)(9).
11Id. and Wis. Stat.
section 766.01(2), which states the Wisconsin Legislature's intent
that marital property is a form of community property.
131983 Wis. Act 186.
17Planners need to discuss the
full impact of reclassifying assets with clients. They also should
consider the possible impact of I.R.C.
section 1014(e), which allows a basis adjustment at the death of the
donee, when the gifted property returns to the donor under the donee's
estate plan, only if the gift is completed more than one year before the
20In accordance with the final
Treas. Regs. issued under I.R.C.
section 2518, within nine months of the death of the wife the
husband could potentially disclaim at least a one-half interest in the
jointly held property that is passing to him by right of survivorship.
TD 8744 62 Fed. Reg. 68183 (12/31/97). See Pratt and Hauser,
Estate Planning With Tenancy by the Entireties Property, Vol.
LXXII, No. 7, Fla. B. J. p. 46 (1998). See also, Scholtes,
Final Disclaimer Regulations Offer Estate Planning
Opportunities, Vol. 12, No. 3, Prac. Tax Law. (Spring 1998).
Retirement Income Security Act
22See Boggs v.
Boggs, 117 S. Ct. 1754 (1997). See also Wis. Stat. §§
766.62(5) and 766.31(3).
23 "Qualified Heirs" are defined
as: 1) a member of the decedent's family, or 2) any individual who has
been actively employed by the business for at least 10 years prior to
the date of the decedent's death. I.R.C. § 2057(i)(1)(B).
24The IRS Restructuring and
Reform Act of 1998 converted what originally was an "exclusion" into an
estate tax deduction.
25For example, if one spouse has
significant qualified retirement plan benefits, consideration should be
given to classifying the family-owned business interest as individual
property of the spouse without retirement benefits.
26Treas. Regs. 20.2031-1(b).
27Estate of Louis F. Bonner
v. U.S., 84 F.3d 1005 (5th Cir. 1996). But see Estate of Wayne
Utiynnk, 110 T.C. 24 (1988).
28Id. The court in
Bonner rejected the IRS position that assets in the marital
trust of the first spouse to die and the estate of the second spouse to
die had merged and therefore no discount should apply for the second
29If a fractional interest in
marital property is used to fund a credit shelter trust at the first
spouse's death, the amount of assets protected by the applicable unified
credit amount should be increased by the amount of the discount that can
be claimed with respect to that fractional interest. Likewise, discounts
should apply when valuing the surviving spouse's marital property
interest at his or her death and when valuing marital trust assets
includable in the surviving spouse's estate to the extent the marital
trust was funded with a partial interest in marital property at the
first spouse's death.
30See Willms, Family
Limited Partnerships and Limited Liability Companies: New Estate
Planning Tools for the 90s, Vol. 67, No. 3, Wis. Law., 16 (March
31Rev. Rul. 59-60, §
4.02(g), 1959-1 C.B. 237; Estate of Little v. Comm'r, 51 T.C.M.
(P-H) 73 (1982); Hooper v. Comm'r, 41 B.T.A. 114 (1940);
Bardahl v. Comm'r, 34 T.C.M. (P-H) 673, 918 (1965); South
Carolina National Bank v. McLeod, 256 F. Supp. 913 (D. S.C.
33Estate of Little v.
Comm'r, 51 T.C.M. (P-H) 73 (1982); MacDonald v. Comm'r,
230 F.2d 534 (7th Cir. 1956). But see I.R.C.
§ 2703(a); Treas. Reg. § 25.2703-1(a)(1).
36Wis. Stat. §§