James Gandolfini’s Estate Tax Debacle

James Gandolfini, the actor best known for playing Mafia boss Tony Soprano in the TV show “The Sopranos,” died on June 19, 2013 while on vacation in Italy. He was 51.

Gandolfini left a will, but thanks to poor planning and drafting, the IRS will be the biggest beneficiary of his estate. With an estate worth an estimated $70 million to spread around, you’d think there would be more than enough for everybody to be happy. But there will be some tears shed when someone has to sign checks totaling $30 million to the IRS and the State of New York for federal and state estate tax.

In his Gandolfini-Will.pdf, after giving $1.6 million to various friends and relatives and making provisions for his personal property and his house and land in Italy, Gandolfini split the remainder of his estate among four people — 30 percent each to his two sisters, 20 percent to his wife Deborah Lin, and 20 percent to his 9 month old daughter.

It has been reported that he also had a separate trust fund set up for his wife and at least one other trust for his 13-year-old, son Michael which includes a $7 million life insurance payout, which probably won’t be subject to estate tax.

Everything that goes to his wife passes tax free due to the unlimited marital deduction. But that’s the end of the good news. The will specifies that all taxes be paid before the rest is divided up. This is a big error in the document. This means that Deborah Lin will get 20 percent of $40 million, not 20 percent of $70 million. I’m glad I’m not the lawyer who wrote that tax clause.

That mistake in the tax clause is an excellent example of the perils of relying on forms, whether a lawyer uses them and doesn’t really understand them, or you get the forms yourself off the internet. Would you have known there was an error in that tax clause or that it was an inappropriate tax clause for this disposition? I’ll bet not. It’s a mistake that will cost Deborah Lin millions. Do you still think you can write your own will?

James was a resident of New York, which has an estate tax that incorporates a free pass on the first $1 million and then taxes the rest on a rate table that climbs to 16 percent for everything over $10.1 million. A marital deduction is available in New York too, but only for the part that goes to the surviving spouse. What is paid to New York (about $10 million) gets deducted on the federal estate tax form, but that still leaves about $20 million more in federal taxes for a total of $30 million.

That bill is due in nine months, so some assets are going to have to be sold to pay it on time. Even with an extension of time to pay, a big chunk of it will be due at that time and like every other deferred payment, interest will accrue.

What can we learn from this “nightmare” as New York Daily News consultant, William Zabel, calls it?

First, consider postponing more tax liability by either leaving more of your estate to your surviving spouse or by leaving it in a trust with income and some principal for her benefit with the remainder going to other family members. That reduces the tax bill greatly and takes much better care of your spouse. Keep in mind, however, that this only defers the tax until the death of the surviving spouse.

Second, consider making lifetime gifts to beneficiaries or to trusts for their benefit and pay the gift tax. Yes, the gift tax is applied at the same rate as the estate tax, but New York doesn’t have a gift tax. (Only Minnesota and Connecticut do.) Plus not only is the principal amount of the gift out of your estate but also the money you paid in gift taxes. It’s like getting a 20 percent discount on the transfer tax if you pay it during life rather than from your estate.

Put another way and using small numbers for clarity, if you have $140 to give and the tax rate is 40 percent, you can give someone $100 and pay $40 in tax. If you leave it to them in your will, $56 goes to pay taxes and they get $84. The result is 16/84 or about 20 percent better with the lifetime gift.

Third, be wary of tax clauses and even worse, having a will without a tax clause. Make sure none of the tax burden comes out of your surviving spouse’s share or a share for charity. If Deborah Lin were to get 20 percent of $70 million versus $40 million, she’d get $6 million more, the other remainder beneficiaries would get $3 million less and the IRS and NY would get $3 million less.

Get competent advice from an estate planning attorney and consider other techniques to reduce the impact of the estate tax. For assets of this amount, there are Grantor Retained Annuity Trusts, Family Limited Partnerships, Charitable Remainder and Charitable Lead Trusts, sales to Intentionally Defective Grantor Trusts, and myriad other techniques available to reduce the tax.