Patrick D. Newton's Estate Planning Blog

Do I have to file Gift Tax returns for the gifts to my Insurance Trust?

2011-09-02T16:39:00.001-04:00

Filing a gift tax return for an ILIT, even if not technically required because all gifts are below the annual exclusion, is a good idea. It starts the statute of limitations for an audit of the gift. It allows you to decide affirmatively whether GST exemption is allocated. The GST Annual Exclusion does not apply to a gift in trust, unless very strict and unlikely criteria are met (only one beneficiary, must be includable in that beneficiary's taxable estate). So to create a GST Exempt Trust, exemption must be allocated. If the ILIT qualifies for automatic allocation of GST exemption, then you are probably OK not filing, but I do not like to rely on automatic allocation.

WLOS ABC 13 News :: Top Stories - Attorney Sam Neill Admits Guilt

2011-05-18T09:48:00.000-04:00

WLOS ABC 13 News :: Top Stories - Attorney Sam Neill Admits Guilt

Trust Protectors / Trust Advisors

2011-03-22T12:08:00.000-04:00

Yesterday/s Advisor's Forum presentation discussed Trust Protectors and how their use in a trust can help the trust accomplish its goals. The concept of a Trust Protector is to grant someone who is not a trustee or beneficiary certain powers over the trust. These powers often include:

The power to remove and appoint trustees
The power to make modifications to the trust in light of changes in law, particularly tax law
The power to correct errors in the drafting
The power to settle disputes between cotrustees

Additional common powers are rather technical. I am in favor of utilizing Trust Protectors as a way to create flexibility in the trust and help keep the trust, its trustee and its beneficiaries out of the court system to savve costs.

Since Trust Protectors are not defined in North Carolina law, their powers are all determined under the language of the trust instrument. I typically use the designation "Trust Advisor" as I find it sounds more palatable than Trust Protector.

Irrevocable Life Insurance Trusts

2011-01-25T15:51:00.001-05:00

Today's Advisor Forum call was excellent. Bill Conway and Louis Shuntich discussed Irrevocable Life Insurance Trusts (ILITs) from a Advisor Team approach. An ILIT is an irrevocable trust that holds life insurance. An ILIT is used to make the death benefit escape estate tax. Life insurance already escapes income tax. Avoiding both tax systems makes life insurance a very attractive investment for the future of your family.

With the estate tax exemption climbing to $5 million, many taxpayers may believe that estate planning and estate tax planning in particular are no longer needed. Wise families understand that taxes are just one of the many ways family wealth can be confiscated. Other major risks, which can be far more devestating that taxes, include lawsuits, divorces, and market risk. Appropriate life insurance in a well-designed irrevocable trust can address and eliminate these risks.

One rather dramatic planning idea that could be excellent for many families is to utilize the new $5 million gift tax exemption by making a large gift to an ILIT that purchases a single premium life insurance policy. This could create a huge wealth transfer advantage for a family. This is particular attractive considering the potential "claw-back" of gifts into the estate tax base at death if the estate tax exemption returns to $1 million in 2013. This is because the "claw-back" would only bring back in the value of the gift at the time of gift, and not any appreciation on that gift. If the gift is used to buy Life Insurance, then there is a huge leverage for the after tax wealth transfer.

Again, great seminar Bill & Lou!

Patrick

Employee Social Security Tax reduced 2%

2011-01-18T11:21:00.000-05:00

As part of the new Tax Relief Act, payroll taxes have been reduced 2% for for the Employee portion. Starting January 1, 2011, Social Security tax on the first $106,800 of an employee's earned income are reduced from 6.2% to 4.2%. If you are a wage earner, what will you do with your extra money!??

Self-employment tax is also reduced from 12.4% to 10.4% on 2011 earnings.

Tidbits from the new Tax Laws

2011-01-03T11:56:00.002-05:00

Individual tax rates will remain at 2010 levels (10, 15, 28, 33 and 35%) for two more years. If no action had been taken, all of those tax rates would have increased.

Tax on long-term capital gains and qualified dividends remains at 15% for two more years. If no action had been taken, capital gains would have been taxed at 20% and dividends would have been taxed as ordinary income.

Taxpayers will not see their itemized deductions or personal exemptions limited due to income levels in 2011 or 2012.

The deduction for direct charitable donations from an IRA for those 70 1/2 or older was extended for two more years and such contributions made before January 31, 2011, can be attributed to 2010.

The AMT (alternative minimum tax) exemption for a married couple was increased from $45,000 to $72,450.

Investments in new business equipment from September 8, 2010, through the end of 2011 qualify for a deduction of 100% of their cost in the year of acquisition. Acquisitions in 2012 qualify for a deduction of 50% of the cost. There are, of course, restrictions that apply.

Why should I want a “Grantor Trust” ?

2010-11-24T12:39:00.000-05:00

A Grantor Trust is a Trust that is ignored for tax purposes. Back when Federal Income Tax Rates were much higher, wealthy individuals would establish many trusts for their descendants to push income in to the lower brackets. The trusts were designed to give the Grantor lots of power over the various trusts. Congress decided to maintain the integrity of the Federal Income Tax System by implementing the Grantor Trust Rules. If a Grantor retains certain powers over a trust, then the trust is ignored for income tax purposes. This, in effect, keeps all of the income of the various trusts that "violate" the Grantor Trust rules combined back on the Grantor's income tax returns at the Grantor's marginal bracket.

Back when income tax rates were much higher, the Grantor Trust rules limited the usefulness of trusts. In fact, a trust that violated the Grantor Trust rules was said to be a defective trust. A trust that did not work. If designed for income tax planning, that is correct, the trusts would no longer meet those goals.

Today, Income Tax Rates are lower. Additionally, to further limit the utility of trusts to dilute the income tax base, the tax brackets for trusts are greatly compressed. That is, a trust hits the highest income tax bracket at only around $11,000 of taxable income. This compression of the brackets makes using trusts to manipulate income tax rates unattractive. The Grantor Trust rules are actually no longer needed, but they remain in the law.

The Grantor Trust rules provide a distinct tax advantage from a gift and estate tax point of view. If a gift is made to a properly drafted trust, that trust will keep the assets of the trust out of the Grantor's taxable estate. At the same time, the trust will be ignored for income tax purposes.

This dual tax status trust is essentially a vehicle to allow you to make a gift to your spouse, children or other beneficiaries that can grow income tax free. Income tax-free compounding is a powerful tool for the transfer of wealth.

Remember the estate tax is scheduled to return on 01/01/11 with a $1 million exemption and a 55% highest rate. The assets in a properly structured Grantor Trust not only grow income tax free during the grantor's life, but also will not be subject to an estate tax hit.

Grantor trusts is one more tool to help you Disinherit Uncle Sam.

Patrick

Does my LLC need to have formal meetings?

2010-10-24T16:45:00.000-04:00

The law does generally not require meetings of Limited Liability Companies, Trusts, and Limited Partnerships. However, a Limited Partnership or Limited Liability Company (LLC) is a business, and most businesses do have regularly scheduled meetings of the management team and the owners. To help make sure my clients formalize this, the LLC operating agreements I draft do require an annual meeting. There are advantages to having regular meetings. Among the advantages are:

An opportunity to discuss the business of the Company.
An opportunity to discuss opportunities and problems that arise during the management of the Company.
An opportunity to get the family together for a business meeting.
The expenses of the business meeting, including travel, food, and lodging, are tax deductible to either the individuals or the Company.
In some cases, only part of the travel, food, and lodging are tax deductible. Seek the opinion of your CPA or tax preparer to determine how much is tax deductible in your particular case.

Every Member, Manager or Partner should be notified of the meeting far enough in advance to attend the meeting. Evidence of the notice in writing is not required, but can support the business purposes of the Company, as well as tax deductions for the cost of the meeting.

Fully Funding Your Living Trust to Avoid Probate

2010-10-21T23:09:00.000-04:00

I often meet with people who wish to avoid probate. Probate is a public court proceeding required to transfer a person's assets at death. Probate can be lengthy and expensive. All assets owned in individual name (or jointly without survivorship) can only transfer to your loved ones through probate. Ways to avoid probate include survivorship rights, beneficiary designation and use of a trust. Assets owned jointly with right of survivorship automatically transfer to the survivor at death, but the asset will eventually end up in probate at the survivor’s death. Assets such as life insurance are transferred by their beneficiary designation form, but even these can end up in probate if there is a problem with the designation.

I often help my clients to establish a living trust to avoid probate. Of all of the ways to transfer assets, a living trust offers the most flexibility and control. Yet merely creating a trust will not avoid probate. A trust only avoids probate for those assets properly titled to it. Only a fully funded trust can completely avoid probate.

If you have a living trust, I strongly urge you review its funding. Particularly, make sure your safe deposit box is titled to your trust. Please remember when opening new accounts or purchasing new assets to put them in your trust. If you have any questions, please contact me.

Patrick

Using the Beneficiary Controlled Trust

2010-10-20T14:48:00.001-04:00

What is a Beneficiary Controlled Trust?

A Beneficiary Controlled Trust is an estate or gift tax planning technique where parents leave property to their children in a trust rather than outright. As the name implies, the child-beneficiary is the trustee of the trust. Thus, the Beneficiary Controlled Trust.

Why are estate planners and their clients increasingly using Beneficiary Controlled Trusts?

It is easier to explain why, if we first understand that there are essentially two methods to leave property to the typical child, excluding those that are irresponsible, etc., they are:

Outright to the child
In a trust for the child where the child is the trustee

As we are assuming that there are only two methods to leave the property, we need to compare them against one another.

What are the factors used in the comparison?

We start by listing the things that a beneficiary can do when the property is left outright and free of trust with how those same things included in a Beneficiary Controlled Trust.

What can an owner of property do with the property?

There is actually a fairly limited number of things, they can do, they are:

Give the property away
Leave the property to anyone they want
Use the property without paying for the use
Sell the property
Destroy the property
Lose the property to a creditor
Lose the property to a divorcing spouse

Do I understand correctly that you are now going to compare the ability of the beneficiary-trustee of a Beneficiary Controlled Trust to do the same things that an outright beneficiary could do?

Yes, that is exactly correct. Let’s see what the comparison shows:

Give the property away: The beneficiary-trustee of a Beneficiary Controlled Trust may be given the power to make gifts of the property in the trust to anyone other than the beneficiary or the creditors of the beneficiary. In essence, the Beneficiary Controlled Trust is identical to the outright bequest free of trust. We’ll give this an Equal rating.
Leave the Property to anyone they want: The beneficiary-trustee may be given the power to leave the property to anyone other than the beneficiary’s estate, creditors of the beneficiary, or the creditors of the beneficiary’s estate. In essence, the Beneficiary Controlled Trust is identical to the outright bequest free of trust. We’ll give this an Equal rating.
Use the property without paying for the use: The beneficiary-trustee of the Beneficiary Controlled Trust may be authorized to use the property of the trust without paying for the use. In essence, the Beneficiary Controlled Trust is identical to the outright bequest free of trust. We’ll give this an Equal rating.
Sell the property: The beneficiary-trustee may be given the power to sell the property and reinvest the proceeds. In essence, the Beneficiary Controlled Trust is identical to the outright bequest free of trust. We’ll give this an Equal rating.
Destroy the property: The beneficiary-trustee may not be given the power to destroy the property. The Beneficiary Controlled Trust provides more property protection than an outright bequest. We’ll give the Trust a Superior Protection rating.
Lose the property to a creditor: The Beneficiary Controlled Trust may be prepared in such a manner that creditors of the beneficiary-trustee may not attach assets held in the Beneficiary Controlled Trust. The Beneficiary Controlled Trust provides better creditor protection. We’ll give the Trust a Superior Protection rating.
Lose the property to a divorcing spouse: The Beneficiary Controlled Trust can be prepared such that a divorcing spouse has little or no rights to the Beneficiary Controlled Trust’s property. The Beneficiary Controlled Trust provides better asset protection. We’ll give the Trust a Superior Protection rating.

Now, let’s see how the Beneficiary Controlled Trust did in the item by item comparison:

Give the property away	EQUAL RATING
Leave the property to anyone they want	EQUAL RATING
Use the property without paying for the use	EQUAL RATING
Sell the property	EQUAL RATING
Destroy the property	SUPERIOR PROTECTION
Lose the property to a creditor	SUPERIOR PROTECTION
Lose the property to a divorcing spouse	SUPERIOR PROTECTION

Since the Beneficiary Controlled Trust is so far superior to outright bequests, why doesn’t everyone use them?

The primary reason is many estate planning practitioners are simply not familiar with the technique. In addition, some clients simply do not want, what they perceive to be, “complicated estate plans.”

Are Beneficiary Controlled Trusts complicated?

No, they are not. An easy comparison is the Family or Credit Shelter Trust that holds the estate tax free amount for the first spouse to die. An annual tax return is due and accounting and monitoring must be done. However, it seems to me that the benefits provided by the Beneficiary Controlled Trust far outweigh the additional costs after the surviving spouse has died.

Successor Trustee? Tips on Avoiding Potential Liability

2010-10-20T14:32:00.000-04:00

To help you avoid personal liability in connection when serving as trustee, follow three rules:

Document all transactions, including any reasons for making or not making distributions. While you may perceive the risk of getting sued as low, you cannot ignore the possibility. When you are acting as a trustee and are essentially in control of someone else's assets, you can easily become the focus of any anger or frustration that beneficiaries may feel.

Keep beneficiaries well informed of trust business. Be friendly and cooperative. It is much more difficult to sue someone with whom you have a good relationship. Maintain carefully documented files. Seek advice from experts.

Consider the dynamics of a lawsuit against a trustee. Judges and juries alike tend to have more sympathy for the party who appears to be “right.” If you have sloppy records (or have none), or if you have not sought help when you came up against something beyond your expertise, or if you have not provided beneficiaries with information that you should have, you will not be given the benefit of the doubt.

Inheritance Trust to Protect an Inheritance from Creditors

2010-10-19T09:32:00.000-04:00

Many of my clients are deeply concerned about how litigious our society has become and fear that their assets may one day be taken by creditors. As a result, they desire to legally protect their assets from creditors, including the possibility of divorce. If you share these concerns, I want you to be aware of an important technique that can asset protect an inheritance and provide an important piece of your estate plan.

The traditional estate planning process focuses exclusively on passing assets downstream to beneficiaries (i.e., to children and grandchildren), often ignoring a potential inheritance from parents or other family members. However, Americans are living longer and longer and trillions of dollars will change hands in the coming decades. Most of these assets will be transferred in a manner that is not protected from the claims of creditors or former spouses.

The laws of most states, including North Carolina, prohibit so-called "self-settled trusts" - an irrevocable trust you establish for your benefit, yet which purports to protect the trust assets from creditors. Therefore, once you receive an inheritance, it is too late to asset protect it. For potential inheritances, we can, by creating an Inheritance Trust to be the recipient of the inheritance, protect these assets. An Inheritance Trust legally protects the inherited assets yet allows you to access them as necessary. It also may remove a substantial portion of the assets from your potential taxable estate, thereby saving estate taxes at your death.

If you want to know more, please contact me.

Patrick

Alaska Community Property Trusts

2010-10-18T11:32:00.001-04:00

There is a planning strategy that could reduce income taxes for married couples. The Alaska Community Property Trust permits married couples to transfer assets to a spouse at death, totally eliminating capital gains on all appreciated assets owned by the couple.

Married couples who live in the ten Community Property states (Alaska, Arizona, California, Idaho, Louisiana, New Mexico, Nevada, Texas, Washington and Wisconsin) and hold their assets as community property receive a full "ste-up" in basis at the death of the first spouse for purposes of determining capital gains tax when the property is later sold. Consequently, residents of community property states benefit from a significant capital gains tax savings by holding appreciated property as community property, an advantage unavailable to the rest of the nation, where only the assets of the deceased spouse would receive a step-up in basis (typically considered 1/2 of joint property).

Alaska, however, specifically allows non-Alaska residents who meet certain criteria to "borrow" the features of Alaska Community Property law and eliminate capital gains on their appreciated assets at the death of the first spouse. It is now possible for you to transfer your appreciated property to a special trust drafted to take advantage of Alaska Community Property Trust features.

Upon the first spousal death, the survivor of beneficiaries can then sell the property paying tax only on the gains above the date of death value. If you read this, and are interested, please contact me.

Note: The rules for basis step up in 2010 are particular to 2010, this post does not address the 2010 issues.

Patrick

Business Exit Planning Using Charitable Strategies

2010-10-02T11:26:00.001-04:00

Business owners usually have four goals when they leave their businesses: retire from the business; sell to a new owner (family members, employees, or third parties); minimize taxes and maximize profits. For those who are already charitably inclined, business exit planning using charitable tools allows them to add a fifth goal: doing good things for their favorite charity or their community.

Tools for Business Exit Planning Involving Charitable Giving

Three tools involving charities are typically used in business exit planning: charitable remainder trusts, gift annuities and charitable lead trusts.

A charitable remainder trust (CRT) is a tax-exempt trust. It is primarily an income tax planning tool with some estate and gift tax benefits. With a CRT, the appreciation in assets can be realized without immediate gain recognition tax-free, a stream of payments created for the donor and a deferred benefit provided to a charity. An income tax deduction, gift tax deduction or estate tax deduction is based on the remainder value that passes or is projected to pass to charity at the end of the trust term. Certain private foundation rules apply, which can be problematic.

A gift annuity is essentially a bargain sale in which the consideration paid by the charity is in the form of annuity payments. Code Section 72 specifies how the income is categorized; i.e., how much is return of principal and how much is ordinary income. Code Section 1011 specifies how gains are recognized, for example if the gift annuity is funded by contribution of appreciated assets. Code Section 415 limits payments to one or two persons. Private foundation rules do not apply to gift annuities.

A charitable lead trust (CLT) is the opposite of a charitable remainder trust in that the income stream is paid to charity with the remainder going to private individuals. A CLT is primarily an estate or gift tax tool. If it is set up as a grantor trust, it can also provide some income tax benefits. Unlike a CRT, a CLT is not a tax-exempt trust. Some private foundation rules apply to CLTs.

Business Succession Pitfalls

When trying to do charitable planning in conjunction with business exit planning, there are three potential pitfalls: having the transaction treated as a prearranged sale, the unrelated business taxable income (UBTI) rules, and the rule against self-dealing, which is one of the private foundation rules.

Prearranged Sales

Most business owners want a high degree of control, especially when it comes to selling their business. Often they will want to negotiate the sale, execute a binding sale contract, and then transfer the property subject to the sale obligation. That will not work because it violates the prearranged sale rule. Violating that rule means that the IRS will treat the donation as but one step in a unified transaction. Revenue Ruling 78-197 provides:

[The IRS] will treat proceeds of a redemption of stock...as income to the donor only if the donee (charity) is legally bound or compelled by the corporation to surrender the shares for redemption.

Under Rev. Rul. 78-197, the key then is whether the charity (or the Trustee of the CRT or CLT) is obligated to sell the donated property to the buyer that the donor has identified.

If the donor violates the prearranged sale rule, the sale proceeds will be income to the donor and the donor will not avoid recognizing the capital gains on the sale.

Planning Tip: The donor can identify and let potential buyers know that the business is for sale and even negotiate a sale price as long as the charity or Trustee is not obligated to go through with that sale.

Unrelated Business Taxable Income (UBTI)

All tax-exempt organizations and charitable trusts are subject to tax on UBTI. UBTI is income from a trade or business that is owned and regularly carried on by a charity or charitable trust that is not substantially related to the tax-exempt function of the charity.

Exceptions include dividends, interest, annuities, royalties, certain rents from real and personal property and capital gains - unless they are derived from debt-financed property.

Income from debt-financed property is UBTI regardless of whether the organization is actually engaged in a trade or business. Debt-financed property is any property held to produce income and with respect to which there is acquisition indebtedness. Acquisition indebtedness generally means indebtedness incurred when acquiring or improving the property.

A charity has acquisition indebtedness when it acquires property (by a gift or purchase) that is subject to debt or borrows against the property to make improvements. Property is considered "debt-financed" even when the charity or trust acquires the property "subject to" the debt.

There are, however, a couple of exceptions:

An organization will not recognize UBTI solely because the property is debt-financed property for 10 years after receipt if the transfer occurs because of the donor's death.
Lifetime gifts are not considered "debt financed" if three conditions are met: the organization does not assume the debt, the donor had owned the property for more than five years at the time of the contribution, and the debt had existed on the property for more than five years at the time of the contribution.

The Income Tax Impact of UBTI

A charity, including one with gift annuities, must pay tax on all of the UBTI it receives.

For CRTs, any UBTI is confiscated through a 100% excise tax. (The rule used to be different - that if a CRT received any UBTI in a year, all of its income for that year was treated as UBTI.)

For CLTs, when it makes a distribution of the unitrust or annuity amount to the charity, it takes a 100% deduction. However, if the CLT has UBTI, this deduction drops to 50% if paid to a public charity and to 0% if paid to a private foundation.

Self-Dealing

Code Section 4941 lists six specific acts of self-dealing for a private foundation:

The sale, exchange or leasing of property between a disqualified person and the foundation, regardless of the size of the transaction;
Loans of money or any other extension of credit between a disqualified person and the foundation;
The furnishings of goods, services or facilities between a disqualified person and the foundation;
The payment of compensation or reimbursement of expenses by the foundation to a disqualified person;
The transfer of income or an asset from the foundation to a disqualified person for the disqualified person's use or benefit; and
An agreement by the foundation to pay a government official, other than an agreement to employ the official for any period after the termination of his government service, if the official terminates his government service within a 90-day period.

Disqualified persons (also defined in Section 4941) are the donor; the trustee; family members (which include the grantor's spouse, ancestors, children, grandchildren, great-grandchildren and the spouses of these individuals); and controlled business organizations (those in which 35% or more of the ownership interest is controlled by disqualified persons).

The tax code makes the private foundation self-dealing rules applicable to CRTs and CLTs. This essentially prohibits all transactions between a CRT or CLT and the donor (and the donor's family) and any business in which the donor and his family have a 35% or greater ownership interest.

Planning Tip: Charities are not disqualified persons, so the remainder charity could purchase something from the trust and that would not cause a self-dealing problem.

Planning Tip: Self-dealing does not apply to transactions involving gift annuities that are maintained only by public charities. This makes gift annuities an important planning tool in business succession planning.

Conclusion

Incorporating charitable planning tools in business exit planning provides unique opportunities for the business owner who is already interested in charitable giving, as well as providing excellent opportunities for the professional advisors to work together.

My son has married a woman with two children and they have just had one of their own. If I leave assets to my grandchildren, will my son’s stepchildren be included?

2010-09-22T11:06:00.000-04:00

No, unless....

Step-relations are not “descendants” for purposes of North Carolina inheritance law. Unless your son legally adopts them or you specifically include them in your definition of descendants in your estate planning documents they will not inherit. This is not true for half-relatives. In North Carolina a half is generally as good as a whole. For example, if you die intestate (without a will) and you leave a full sibling and a half-sibling, they will share your estate.

Transferring Business Interests to Family Members: Sale of Non-Voting Stock Interests to Grantor Dynasty Trusts

2010-09-01T15:52:00.001-04:00

Most of us have at least one client who has a family-owned or closely held business interest as a major part of their estate. Typically, that client has done nothing to plan for the succession of the business. That kind of planning can be challenging because of the complex tax issues and the human element (egos, relationships, etc.) involved. On the other hand, it can be most rewarding, and it offers excellent opportunities to create a deeper relationship with an existing client and build a relationship with the next generation. It also offers the opportunity to create ongoing professional relationships with other key advisors, as we must work together to achieve the best results for our mutual client.

Below, we will examine a case study of how clients can benefit from selling non-voting stock in a closely held business to a specific type of "grantor" dynasty trust.

Our Case Study

The Facts: Harry the husband, age 62, is married to Wilma the wife, age 58. This is a second marriage for both of them. They have no prenuptial agreement and no estate plan. Steve, who is Harry's son, is actively involved in Harry's business. Wilma's daughter Dottie is unemployed and not involved in Harry's business, which Wilma and Dottie resent. Harry and Wilma have one joint child, Mark, who is a minor and is also not involved in Harry's business. Neither Harry nor Wilma has used any of their $1,000,000 lifetime gift tax exemption.

Harry owns 100% of a business that is an S-corporation. It is very successful and has a current fair market value of $10 million. It also has significant cash flow and high growth potential. Harry's desire (which Steve shares) is for Steve to own and continue the business after Harry retires or dies.

There are significant other assets in the estate, including their home and other investments. Some are owned jointly by Harry and Wilma, and some are owned solely by Harry.

Under the probate laws of the state in which they live, if Harry dies intestate Wilma will receive half interest in each of Harry's assets and Steve and Mark will each receive a one quarter interest in each of them. As a result, Wilma, as Mark's guardian, will end up controlling 75% of the business while Steve will only control 25%. In addition, assuming Harry does not die in 2010, there will be a potentially huge estate tax liability. This is not what Harry wants to happen.

Harry's Goals and Objectives: After meeting with his team of advisors, Harry has defined his goals and objectives as:

To have a comprehensive plan that will ensure ownership of the business will pass to his son Steve. (Steve also wants the security of knowing the business will one day become his.)
To be in control of the timing of the transfer of the business.
To treat his stepdaughter and his younger son fairly.
To have enough cash flow for now and to provide for Wilma if he dies first.
To save estate taxes.

Harry also understands that Steve does not have the cash to buy the business from him.

To meet Harry's goals and objectives, here is the plan his advisors recommend and why:

Phase 1: Reorganize and Recapitalize the S-Corporation

In a tax-free reorganization, convert the S-corporation to a limited liability company taxed as an S-corporation with voting and non-voting common units.

Harry owns all of the 1,000 outstanding shares of the company. They are all voting shares. After the reorganization and issue of voting and non-voting membership units, Harry still owns 100% of the business, only now it is 10 LLC membership units (1%) that are voting and 990 (99%) that are non-voting. Why reorganization of the S-corporation into an LLC is part of the plan will be explained later.

Phase 2: Create Dynasty Trusts

Establish an irrevocable trust for each child that is designed so that its income is taxable to Harry and make initial contributions to the trust.

Harry creates three irrevocable grantor trusts, one for each child, in a jurisdiction that permits perpetual private trusts. The trusts are all "grantor" trusts for income tax purposes, but not for estate and gift tax purposes. These are known as Irrevocable Deemed Owned Trusts (IDOTs). Some call them Intentionally Defective Grantor Trusts (IDGTs).

Planning Tip: It is possible (and an excellent idea) to design the IDOTs so that their income being taxed to Harry can be stopped if that becomes desirable later.

Harry makes a $600,000 cash gift to the trust established for Steve. This is a taxable gift that must be reported on a Federal gift tax return (IRS Form 709). However, no gift tax will be due because $600,000 of Harry's $1 million lifetime gift tax exclusion will be used to shelter the gift from taxation.

Harry will also allocate $600,000 of his generation skipping transfer tax exclusion to Steve's trust. Steve's trust will therefore have a zero inclusion ratio (i.e., have a 0% tax rate) for generation skipping transfer tax purposes.

Planning Tip: In 2010, because the generation skipping transfer tax is suspended, this allocation cannot be made. Therefore, consider making late GST exemption allocations in 2011 when the GST returns, if Congress amends the tax code to permit doing so. Alternatively, delay implementing Phase 2 until 2011.

When Harry and Wilma make gifts to the trusts for Dottie and Mark, they do the same kind of allocations.

This trust structure provides a huge benefit to their descendants because the trusts' assets will never be included in their descendants' estates for estate tax purposes.

Phase 3: Sell Non-Voting Membership Units to Steve's Trust for an Installment Note

To give Steve ultimate ownership of Harry's business, start by selling all of the non-voting membership units to the dynasty trust for Steve.

To make a private sale or gift between family members of something valuable that does not have a known value, the IRS requires that a qualified valuation expert determine its fair market value. When what is sold or given away is an interest in a business, there are two steps to the valuation. First, the balance sheet assets owned by the business (real estate, specialized equipment, inventory, etc.) are valued. Then a business evaluation is performed to determine whether and to what extent the value of the assets underlying an interest in the business needs to be adjusted for lack of control over the business and lack of marketability of the membership interests.

The reason that the S-corporation was reorganized into an LLC taxed as an S-corporation is that limitations on the transferability of a business interest are disregarded in the valuation if they are greater than the default provisions of the state law that govern the business. The default provision for corporations is that there is no limitation on transferability. On the other hand, some states' default provision on LLC membership transfer is that all members must consent.

When the adjustments for lack of control and lack of liquidity are made to non-voting interests in an LLC, it is not uncommon that their cumulative effect is to depress the fair market value by a significant amount. In this case, we assume that the non-voting units' value will be depressed 40% because of lack of control and lack of marketability. Thus, the non-voting units will have a value of $6,000 per unit, making the total value of the 990 non-voting units $5,940,000.

Voting units will have a premium value to reflect the control value. In this example, the voting units have an appraised value of $12,000 per unit, making the total value of the 10 voting units equal to $120,000.

The fair market value of the entire company, sold as a unit, is still $10 million, but the value of the parts does not add up to $10 million! That it is only $5,940,000 + $120,000 = $6,060,000.

In this phase, Harry sells his 990 non-voting units to the dynasty trust for Steve using a 20-year installment note, payable annually. The note is for $5,940,000 (the fair market value of the 990 non-voting units) and is at a rate of 4.26% (which is slightly above the current long-term AFR rate). Based on the value and terms of the note, the trust will pay Harry $447,197 every year for 20 years. This is a legitimate arms-length business transaction because Steve's dynasty trust is a creditworthy borrower since its assets ($600,000 initial gift + $5,940,000 in LLC units) exceed the value of what it has bought by more than 10%.

Planning Tip: There is no "bright line" test for what is a commercially reasonable loan-to-value ratio. Many practitioners use 10%, but some are more comfortable at 20%.

Planning Tip: Make sure the installment note is handled just like an installment sale to a non-family member or to a bank. Have a signed pledge or security agreement, pay any tax required, do any filings required. Make sure you have a documented paper trail.

The Outcome

Company Ownership and Control

After Phase 3 is completed, Harry owns 10 voting units, which gives him 100% control of the business and 1% of the equity. The dynasty trust for Steve owns 990 non-voting units, which gives it no control over the business and 99% of the equity. The dynasty trust also has $600,000 in cash that Harry gifted to it as seed capital.

Income Tax Reporting

Harry is deemed to be the "owner" of the dynasty trust for Steve for purposes of reporting its income. As long as that is so, the dynasty trust for Steve does not have to file a Form 1041 fiduciary income tax return. Instead, an information return is filed, with the dynasty trust income tax information reported to Harry as the trust's deemed owner, for reporting on his personal Form 1040 income tax return.

Income Tax Effect of Sale of Membership Units

Harry's sale of LLC units to the dynasty trust for Steve is a "non-recognition" event. Because Harry is the deemed owner of the trust for income tax purposes, it is treated as a sale by Harry to himself. Thus no gain is recognized on the sale of the stock and no interest income is recognized on the installment note payments. Of course, the trust does not receive a deduction for interest payments made either.

"Pass Through" Dynasty Trust Income

Income from the LLC will be allocated to the unit holders based on their unit ownership percentages. Let's assume the business has $500,000 in net income. Harry owns 10 voting units, which is equal to 1% of the equity. Therefore, Harry will be allocated $5,000 in K-1 income. The dynasty trust for Steve owns 990 non-voting units, which is equal to 99% of the equity. Therefore it will be allocated $495,000 in K-1 income.

Because the dynasty trusts are structured as grantor trusts for income tax purposes, Harry must pay the income tax attributable to all of their income, including the S-corporation income that is allocated to the trust for Steve. But that is what he was doing before the sale of his non-voting units to Steve's trust, so he is paying the same income tax before and after the sale of the units. Harry's payment of the trusts' income tax is not an additional gift to the trusts, which means that every year Harry is transferring, gift tax free, additional estate assets to the trusts for the children.

How the Dynasty Trust Makes the Required Note Payments

We assume for this case study that the LLC will have $500,000 per year of cash flow to distribute to its unit holders. That will provide Steve's dynasty a cash distribution of $495,000 ($500,000 x 99% = $495,000). Thus at the end of year one it will have $1,095,000 in cash ($495,000 from the LLC and the $600,000 that was gifted to it as seed capital). The trustee can thus easily make the $447,197 note payment to Harry.

Planning Tip: If the company does not generate enough income to pay the note, take the same approach as if a borrower can't repay a bank loan. Options would include deferring payment until such time as the business recovers or renegotiating the term or interest rate of the note.

Results After Year One

At the end of the first year, the note has been reduced to $5,745,847 and the dynasty trust has a cash balance of $647,803. The trustee of the dynasty trust could use this cash to:

Invest and save. (Income taxes on the earnings would be taxed to Harry.)
Make distributions to the trust beneficiaries. (Distributions would be gift tax-free.)
Buy life insurance on Harry's life.

Harry has received $5,000 from the LLC and $447,197 from the note payment, for a total of $452,917 in income. He will pay income taxes on this full amount. For example, if he is in a 25% effective income tax bracket (after all deductions), he would pay $125,000 in income taxes, leaving with him $327,917 income to support his and Wilma's lifestyle and/or make annual exclusion gifts to the dynasty trusts for Mark and Dottie, which they could use to buy life insurance on Harry's life. (This would be an excellent way to provide for Mark and Dottie. See explanation under "When Harry Dies" below.)

Planning Tip: A higher income tax rate would mean less income, but there may be other sources of income. For example, Harry is still in control of his company, and he may receive a salary as well as compensation as a Director on its Board.

Planning Tip: Harry may be able to reduce his salary from the LLC if he does not need the cash flow. This would save payroll tax and would give the business more cash flow. However, make sure he receives enough in salary to continue to qualify for group health insurance coverage.

When Harry Dies

If Harry has either consumed or gifted the net after the tax note payments that he receives from Steve's dynasty trust, only the unpaid balance of the note will be included in his taxable estate; there is no asset "build-up" inside his estate as the company grows.

The dynasty trust for Steve is GST "exempt" so that following Harry's death its assets will never be subject to estate, gift or GST taxation (unless the Congress changes the rules).

So are the dynasty trusts established for Dottie and Mark, so the life insurance proceeds received by them on Harry's death are also GST "exempt," providing a legacy for them and their descendants.

Harry could leave the 10 voting units (1%) to Steve in trust, too.

This arrangement would leave Steve's trusts owning 100% of the business and the other children's GST exempt trust shares owning cash.

Harry's wife Wilma will continue to receive the remaining note payments for her support.

Estate Tax Results

Harry has removed $10,600,000 of appreciating assets from his gross estate that, at his death, would be subject to estate tax. Unless the Congress acts quickly, the top rate after the catch-up tax will be 55% in 2011.
Harry has received an asset (the self-amortizing note) that is based on a discounted asset value, frozen (will not appreciate in value) and depreciating (the note principal will decrease over the 20-year note amortization term).
If Harry does not accumulate the note payments, then at the end of the note term (20 years), he will have totally removed the $10,600,000 (plus all future appreciation on this amount) from his gross estate without making a taxable gift other than the initial $600,000 seed capital gift.
The trust assets are in a generation skipping tax-exempt trusts that can include asset protection features. These trust assets are not included in the children's or grandchildren's gross estates at their deaths.

Conclusion

Using this technique, all of Harry's goals and objectives were met. His son Steve would receive the business without having to buy him out, yet Harry could control the timing of the business transfer. He was able to provide for his other children and his wife. In addition, Harry saved substantial estate taxes.

This technique also presents excellent opportunities for strengthening professional relationships, as it requires a team of advisors to work together to achieve these goals. Remember to collaborate as needed. Also remember to present the information to your clients and their advisors in a way that is easily understood and therefore less threatening. In order for your clients to be motivated to act, they must understand what you are recommending and the benefits to them.

No NC Highway Use Tax for transfer into a Living Trust

2010-08-10T11:20:00.001-04:00

The North Carolina General Assembly recently passed a law to clarify that the Highway Use Tax does not apply on a transfer of a motor vehicle to a Revocable Living Trust. The new law became effective July 17, 2010.

The 2013 3.8% Surtax

2010-08-07T16:15:00.002-04:00

A new 3.8% surtax on certain investment income starts January 1, 2013, as part of the health care reform act. While that's a couple of years away, it is not too early to start planning for it, because there are steps clients can take this year that will help reduce or even eliminate it. This post explains the Surtax.

The 3.8% investment income surtax, also called the health care surtax or the Medicare tax, applies to tax years ending after December 31, 2012. The surtax is:

For individuals, 3.8% of the lesser of:

net investment income for such taxable year, or
the excess, if any, of

the modified adjusted gross income for the year, over
the threshold amount.

For trusts and estates, 3.8% of the lesser of:

the undistributed net investment income for the year, or
the excess, if any, of

the adjusted gross income (as defined in Code Section 67(e)) for the year, over
the dollar amount at which the highest tax bracket in Code Section 1(e) begins for the year ($11,200 in 2010).

There are three numbers that determine how this surtax will affect you.

Net Investment Income

This is the sum of gross investment income over allocable investment expenses. For purposes of this surtax, investment income includes interest, dividends, capital gains, income from annuity payments, rents, royalties and passive activity income.

Investment income does not include active trade and/or business income; any of the income sources listed above (e.g., interest, dividends, capital gains, etc.) to the extent it is derived in active trade and/or business; distributions from IRAs and other qualified retirement plans; or any income taken into account for self-employment tax purposes.

For the sale of an active interest in a partnership or S-corporation, gain is included as investment income only to the extent net gain that would be recognized if all of the partnership/S-corporation interests were at fair market value.

Modified Adjusted Gross Income (MAGI)

Here, MAGI is the sum of adjusted gross income (the number from the last line on page 1 of Form 1040) plus the net foreign income exclusion amount.

Threshold Amount

Married taxpayers filing jointly . . . $250,000
Married taxpayers filing separately . . . $125,000
All other individual taxpayers . . . $200,000
Trusts and estates . . . Beginning of the top bracket (which, for reference purposes only, is $11,200 for 2010)

Organizations at-risk of Automatic Revocation of Tax Exempt Status

2010-07-29T20:34:00.001-04:00

Most nonprofits, other than churches, now have to file an annual tax return with the IRS, even if they used to be exempt from filing due to their small size. Organizations with annual income of less than $25,000 are required to file a Form 990-N, also referred to as an "e-postcard". Failure to file a return for three (3) consecutive years could result in automatic revocation of the organization's tax exemption.

The IRS has recently posted lists of organizations at-risk of automatic revocation on a state-by-state basis. Once an organization's status is revoked, they will likely have to refile to re-establish their exempt status, even if the revocation was not their fault. It would be appropriate for all tax-exempt organization advisers, board members, donors and staff, to double check to make sure that their organizations are not listed. If they are, they need to file a return or contact the IRS to correct their status. If you are in any way associated with a nonprofit, you might want to check to see whether it is listed.
For more information on this matter, see the IRS website, http://www.irs.gov/charities/article/0,,id=225889,00.html

Why do single people need estate planning?

2010-07-23T16:01:00.000-04:00

If you are single, with no kids, and very little assets, you should still have some basic estate planning documents in place. The default rules that state law provide may not be desirable for you.

As a bare minimum, estate planning should provide documents that: (1) instructs who will inherit from you, (2) names who will be in charge of handling your affairs after death, (3) names who will be in charge of handling your affairs if you become incapacitated, and (4) names who will make your health care decisions if you become incapacitated. Therefore, at a minimum, everyone should have THREE documents: (1) a Will, (2) a Durable Power of Attorney, and (3) a Health Care Power of Attorney.

Will

A Will names a Personal Representative to handle your final affairs and states who will receive whatever you may own. Dying without a Will is called dying "intestate", and the distribution of your assets will be governed by North Carolina's "intestacy" statutes. If you have a child or children, then your child or children will receive everything. If have no children, then your parents would receive everything. If you have no children and no living parents, then the recipients of your stuff could be siblings, nieces and nephews, grandparents, aunts, uncles, or cousins (essentially your closest next of kin). If you want to give anything to a friend or significant other, a Will is a must.

If there is some reason to prevent your stuff going to your next of kin, then a Will is a must. For example, if your father is receiving Government Benefits to pay long term care expenses through Medicaid, then allowing him to inherit anything from you would be wasteful.

Durable Power of Attorney

The Durable Power of Attorney (DPOA) grants someone the legal authority to act as your agent. This document allows someone to manage your financial affairs for you, which would be necessary if you ever become incapacitated. A single person who become incapacitated without a DPOA in place will have an unpleasant Court encounter. For example, if your Mother is willing to handle your financial affairs if you become incapacitated, then to do so, absent a DPOA, she will have to sue you to have a Court declare you legally incompetent. She will also have to petition the Court to be named as your Guardian. As your Guardian, she can manage your affairs, but she will have to account to the Court each year on how she used and managed your assets. A properly drafted DPOA can keep you out of the Court system by proscribing a private method of determining your capacity. Alternatively, the question of your capacity can be sidestepped by making a DPOA effective upon signing.

Health Care Power of Attorney

Much like the DPOA, a Heath Care Power of Attorney (HCPOA) grants someone the legal authority to make your Medical Decisions. Again, absent an HCPOA, you would have to be sued and someone appointed Guardian for you. The DPOA and HCPOA work together to keep you out of the Court system if you become incapacitated.

Additional Documents

Additional documents to consider for a single person include a Revocable Living Trust, a Living Will and a HIPAA Medical Release form.

A Revocable Living Trust can be used to avoid Probate if privacy is a major concern for you. A Living Will allows you to state your wishes about your life being artificially prolonged, and a HIPAA Medical Release form will make it easier for your loved ones to learn your condition if you are hospitalized.

Conclusion

Single persons should have estate planning documents in place to avoid costly and embarassing Court procedures if incapacity occurs and to direct purposefully who will receive the assets at death and appoint someone to make sure the final affairs are properly managed.

Special Use Valuation - Property Tax - LLC Issue

2010-07-22T15:46:00.001-04:00

An email came in recently on the North Carolina Estate Planning Section LISTSERV. It discussed how a family owned LLC received a notice from Wake County Revenue Department, that said “This office has determined that the deferred taxes shown on the enclosed statements have lost their eligibility status for deferment.” Approximately $15,000 came due in delinquent non-deferred tax.

The problem is that the Wake County Revenue Department interpreted the application of the quoted statute by looking at the Secretary of State website for the "business purpose" of the LLC. An LLC is created by filing Articles of Organization with the Secretary of State. Articles of Organization do not require, and generally do not state a business purpose. So the Department took a look at the Annual Reports. Their position was that if the Annual Report states other than “Agriculture, Horticulture or Forestry”, then the deferred taxes become due.

The Sender of the email strongly recommended that the Articles of Organization / Articles of Incorporation for entities holding real property in special use deferred status, state in bold letters, AGRICULTURE, HORTICULTURE OR FORESTRY as the business purpose.

For some time now, I have been making sure the Operating Agreement for the entity states its Special Use as its business purpose. This recommendation to add it to the Articles sounds reasonable.

What would a conservation easement do for me?

2010-07-22T14:12:00.000-04:00

The conservation easement is an agreement that permanently restricts the future development or use of your land. You may do this to preserve your land and maintain it in its current condition so that it is preserved for future generations although it may allow limited development. The tax benefits can be significant. Upon donating an easement, you obtain an immediate income tax deduction. At your death, the property is valued for estate tax purposes at a lower value since the development rights have been given away. This may enable your family to keep property they might have been forced to sell to pay the taxes.

Understanding the Significance of Trusts

2010-07-19T14:48:00.003-04:00

This is a topic that is important to clients and all wealth planning professionals - trusts. When used properly, trusts can provide significant advantages to clients and to the advisors who recommend them. There are numerous types of trusts.

Planning Tip: According to a recent survey, 70% of financial advisors expect that more of their clients will establish trusts.

Revocable vs. Irrevocable Trusts

There are two basic types of trusts: revocable trusts and irrevocable trusts. Perhaps the most common type of trust is revocable trusts (aka revocable living trusts, inter vivos trusts or living trusts). As their name implies, revocable trusts are fully revocable at the request of the trustmaker. Thus, assets transferred (or "funded") to a revocable trust remain within the control of the trustmaker; the trustmaker (or trustmakers if it is a joint revocable trust) can simply revoke the trust and have the assets returned. Alternatively, irrevocable trusts, as their name implies, are not revocable by the trustmaker(s).

Revocable Living Trusts

As is discussed more below, revocable trusts do not provide asset protection for the trustmaker(s). However, revocable trusts can be advantageous to the extent the trustmaker(s) transfer property to the trust during lifetime.

Planning Tip: Revocable trusts can be excellent vehicles for disability planning, privacy, and probate avoidance. However, a revocable trust controls only that property affirmatively transferred to the trust. Absent such transfer, the revocable trust may not control disposition of the trustmaker's property.

Planning Tip: Unlike with a trust, one cannot affirmatively transfer title of property during life using a will. Also, whether estate planning is by will or trust, it is important to ensure that the client's property passing pursuant to contract (e.g., by beneficiary designation for retirement plans and life insurance) does not thwart the client's planning objectives set forth in the trust or will.

Asset Protection for the Trustmaker

The goal of asset protection planning is to insulate the client's assets that would otherwise be subject to the claims of his or her creditors.

Typically, a creditor can reach any assets owned by a debtor. Conversely, a creditor cannot reach assets not owned by the debtor. This is where trusts come into play.

Planning Tip: The right types of trusts can insulate assets from creditors because the trust owns the assets, not the debtor.

As a general rule, if a trustmaker creates an irrevocable trust and is a beneficiary of the trust (i.e., it is a so-called self-settled spendthrift trust), assets transferred to the trust are not protected from the trustmaker's creditors. This general rule applies whether or not the transfer was done to defraud a creditor or creditors.

Until fairly recently, the only way to remain a beneficiary of a trust and get protection against creditors for the trust assets was to establish the trust outside the United States in a favorable jurisdiction. This can be an expensive proposition.

However, the laws of a handful of states (including Alaska, Delaware, Nevada, Rhode Island, South Dakota, and Utah) now permit selfsettled spendthrift trusts or what are commonly known as domestic asset protection trusts. Under the laws of these few states, a trustmaker can transfer assets to an irrevocable trust and the trustmaker can be a trust beneficiary, yet trust assets can be protected from the trustmaker's creditors to the extent distributions can only be made within the discretion of an independent trustee. Note that this will not work when the transfer was done to defraud or hinder a creditor or creditors. In that case, the trust will not protect the assets from those creditors.

Planning Tip: A handful of states permit selfsettled spendthrift trusts or what are commonly known as domestic asset protection trusts.

For those clients unwilling to give up a beneficial interest in their assets to protect those assets from future creditors, trusts established under the laws of a jurisdiction that permits self-settled spendthrift trusts or a trust established under the laws of a foreign country, may be appealing.

Asset Protection for Trust Beneficiaries

A revocable trust provides no asset protection for the trustmaker during his or her life. Upon the death of the trustmaker, however, or upon the death of the first spouse to die if it is a joint trust, the trust becomes irrevocable as to the deceased trustmaker's property and can provide asset protection for the beneficiaries, with two important caveats.

First, the assets must remain in the trust to provide ongoing asset protection. In other words, once the trustee distributes the assets to a beneficiary, those assets are no longer protected and can be attached by that beneficiary's creditors. If the beneficiary is married, the distributed assets may also be subject to the spouse's creditor(s), or they may be available to the former spouse upon divorce.

Planning Tip: Consider trusts for the lifetime of the beneficiaries to provide prolonged asset protection for the trust assets. Lifetime trusts also permit the client's financial advisor to continue to invest the trust assets as the client desired, which also helps ensure that trust returns are sufficient to meet the client's planning objectives.

The second caveat follows logically from the first: the more rights the beneficiary has with respect to trust distributions, the less asset protection the trust provides. Generally, a creditor "steps into the shoes" of the debtor and can exercise any rights of the debtor. Thus, if a beneficiary has the right to compel a distribution from a trust, so too can a creditor compel a distribution from that trust.

Planning Tip: The more rights a beneficiary has to compel distributions from a trust, the less protection that trust provides for that beneficiary.

Therefore, where asset protection is a significant concern for the client, it is important that the trustmaker not give the beneficiary the right to automatic distributions (for example, 5% or $5,000 annually). A creditor will simply salivate in anticipation of each distribution. Instead, the client should consider discretionary distributions by an independent trustee.

Planning Tip: Consider a professional fiduciary to make distributions from an asset protection trust. Trusts that give beneficiaries no distribution rights, but rather give complete discretion to an independent trustee, provide the highest degree of asset protection.

Lastly, with divorce rates at or exceeding 50% nationally, the likelihood of a client's child becoming divorced is quite high. By keeping assets in trust, the trustmaker can ensure that the trust assets do not go to a former son-in-law or daughter-in-law, or their bloodline.

Irrevocable Life Insurance Trusts

With the exception of the self-settled spendthrift trusts discussed above, a transfer to an irrevocable trust can protect the assets from creditors only if the trustmaker is not a beneficiary of the trust. One of the most common types of irrevocable trust is the irrevocable life insurance trust, also known as a Wealth Replacement Trust.

Under the laws of many states, creditors can access the cash value of life insurance. But even if state law protects the cash value from creditors, at death, the death proceeds of life insurance owned by your clients are includible in their gross estate for estate tax purposes. Clients can avoid both of these adverse results by having an irrevocable life insurance trust own the insurance policy and also be its beneficiary. The dispositive provisions of this trust typically mirror the provisions of the client's revocable living trust or will. And while this trust is irrevocable, as with any irrevocable trust, the trust terms can grant an independent trust protector significant flexibility to modify the terms of the trust to account for unanticipated future developments.

Planning Tip: In addition to providing asset protection for the insurance or other assets held in trust, irrevocable life insurance trusts can eliminate estate tax and protect beneficiaries in the event of divorce.

If the trustmaker is concerned about accessing the cash value of the insurance during lifetime, the trust can give the trustee the power to make loans to the trustmaker during lifetime or the power to make distributions to the trustmaker's spouse during the spouse's lifetime. Even with these provisions, the life insurance proceeds will not be included in the trustmaker's estate for estate tax purposes.

Planning Tip: With a properly drafted trust, the trustmaker can access cash value through policy loans.

Irrevocable life insurance trusts can be individual trusts (which typically own an individual policy on the trustmaker's life) or they can be joint trusts created by a husband and wife (which typically own a survivorship policy on both lives).

Planning Tip: Since federal estate tax is typically not due until the death of the second spouse to die, clients often use a joint trust owning a survivorship policy for estate tax liquidity purposes. However, a joint trust limits the trustmakers' access to the cash value during lifetime. In these circumstances, consider an individual trust with the non-trustmaker spouse as beneficiary.

Conclusion

Clients can protect their assets from creditors by placing them in a well-drafted trust, and they can protect their beneficiaries from claims or creditors and predators by keeping those assets in trust over the beneficiary's lifetime. By working together, the wealth planning team can ensure that the plan meets each client's unique planning objectives.

What should I do with my old will after I have created a new one?

2010-07-19T14:34:00.000-04:00

Under North Carolina law, a will or any part of a will can only be revoked by a subsequent will or codicil or other revocatory writing executed in the same manner as a will or by being burnt, torn cancelled obliterated or destroyed with the intent and for the purpose of revoking it, by the testator him or herself or by another person in the presence of the testator and at the testator’s direction.

To avoid any possible confusion or question of what your intent is, it is recommended that your destroy your old will upon creating a new, valid one.

Avoiding the 3.8% Surtax

2010-07-14T16:27:00.003-04:00

Today, I hosted an excellent Advisor's Forum teleconference on avoiding the 3.8% surtax presented by Bob Keebler, CPA. The surtax kicks in in 2013, and is an additional 3.8% tax on certain high income earners. The tests for whether or not a person will incur the tax are rather complex, but not terribly complicated.

Will you be subject to the Surtax?

First, you must meet the income threshold before the tax is incurred, the Surtax Threshold. The thresholds are $200,000 for inviduals, $250,000 for married couples, $125,000 for married filing separately, and $11,200 for trusts and estates. The threshold is met if your Modified Adjusted Gross Income (MAGI) exceeds the proscribed levels. For most taxpayers, the MAGI will be the same as Adjusted Gross Income, which is gross taxable income less above the line deductions.

If your income (MAGI) exceeds the threshold in 2013 and later, then you might owe the tax. The next test is you must have Net Investment Income. Net Investment Income is essentially taxable investment income less costs incurred to generate that income. If you have net investment income, then the 3.8% Surtax will apply to the lesser of your Net Investment Income or the excess of your MAGI over the threshold amount.

Examples:

Alice, a single person with $500,000 of wages income, with no investment income, will not be subject to the Surtax.
Bob, a single person with $400,000 of wages income and $100,000 of net investment income, will owe the 3.8% Surtax on the entire $100,000 of his net investment income.
Cathy, a single person with $100,000 of wages income and $400,000 of net investment income, will owe the 3.8% Surtax on $300,000 of her net investment income.

Notice the total income in all three examples is the same, but Alice pays $0 Surtax, Bob pays $3,800 of Surtax, and Cathy pays $11,400 in Surtax.  Cathy did not owe Surtax on ALL of her net investment income because the Surtax is limited to the lesser of her Net Investment Income ($400,000) and the excess of her MAGI ($500,000) over the Surtax Threshold ($200,000).   $500,000 - $200,000 = $300,000 subject to the Surtax.

Ways to avoid the Surtax

The simplest ways to avoid the Surtax is to avoid taxable investment income. Without it, there can be no Surtax imposed. This means investing in Muni Bonds, Life Insurance, Annuities, IRAs.

If you will have taxable investment income, you can minimize your tax by minimizing your MAGI. Traditional IRA distributions will increase your MAGI, but Roth IRA distributions will not. This makes a strong case for many taxpayers to convert their IRAs to Roth in 2010, 2011, and/or 2012.

Why does this tax exist?

I really do not get this tax. I am not sure how much thought goes into tax legislation.  The claim is this tax is designed to help pay for the Health Care Bill. While that may be the justification of the tax, I am very skeptical it will meet that goal, and consequently, I am just not sure if that is its purpose. Because tax legislation is more driven by politics than logic, it is often unclear whether the behaviors of Americans that are driven by tax laws are by design or by accident. Impact studies seem to assume that taxpayers will not modify their behaviors, and if they do not, the study provides a decent look into what the tax cost or revenue to the goverment is. Of course, taxpayers do change their behavior based on the tax laws.  So I see its justification as a means to increase revenue to pay for the Health Care Bill as suspect.

This tax is fairly easy to avoid, which makes it look more like social engineering than a revenue producer. This tax clearly favors wage earners over investers. If it disfavors investing, does that make the tax designed to promote spending over investing? Money spent doesn't generate future investment income, and therefore avoids the Surtax.  The Surtax further favors tax-free investments over taxable investments, so maybe it is designed to encourage taxpayers to lend money to the government. It encourages investing through life insurance for tax-free investing and annuities for tax deferred investing. It favors growth investing over investing for dividends, as there is no Surtax on unrecognized gains. It encourages investing in oil & gas.