12/15/09copyright 2009 scott dondershine1 estate planning concepts in an age of uncertainty scott...

12/15/09 Copyright 2009 Scott Dondershine

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Estate Planning Concepts In an Age of Uncertainty

Scott Dondershine, CPA, Esq. David, Brody & Dondershine, LLP

(703) [email protected]


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Introduction

• Status of the Federal Estate Tax Laws

• Summary of Basis Estate Planning Concepts– Use and Purpose of RLTs– Use and Purpose of ILITs

• Succession Planning for Businesses


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WHY DO I NEED AN ESTATE PLAN?

• Distribute your assets in the time & manner you intend

• Creditor Protection• Avoid Need for Probate• Incapacity Planning• Prevent IRS from

becoming the major beneficiary of your estate


4

Distributing Assets in the Intended Manner

• How should the assets be distributed?– Outright to your

children in a lump-sum?

– Remain in trust until:• Children/grandchildren

reach certain age?• Stagger distributions• Longer period of time

• Special concerns?– Special needs trust?– Education?– Creditors?– Charity?


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Avoid Probate

• Although the states have simplified the procedures:– Still time– Still money– Still public process– Still a hassle

• Assets in trust avoid probate


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Creditor Protection

• Although generally does not protect grantor from his/her creditors:– Can protect kids from their creditors (two

slides from now)– Divorce of a child– Bankruptcy or other creditor

• Exception to general rule for grantors in VA (next slide)


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VA Code Section 55-20.2

• TBE Property Protection for:– Assets held jointly (AS TBE) and then

transferred to trusts– Personal or real property

• May require multiple transfers to take advantage of provision– Intermediate transfer to TBE– Then transfer to the trusts


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Dynasty Trusts

• Like a Tube of Toothpaste (Better off inside)

• Problem with mandatory or staggered distributions


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Incapacity Planning

• Easier to Manage Assets Through Trusts

• Without Trust:– Power of Attorney (“POA”)– Is the POA going to be recognized in the

distant future?– Risk of revocation

• Do not have same risk with a trust and can specify instructions


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Taxes, Taxes,Taxes

• “The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing”

• Jean Baptiste Colbert (King Louis XIV Finance Minister)


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Applicable Exclusion Amount (Unified Credit)

• Shelters assets from:– Estate taxes, or– Gift taxes

• Important to maximize use to minimize taxes

• Has increased as part of 2001 Tax Act

• Increases are then rescinded in 2011


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2001 Tax Act

• Key to understand – The Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”)

• Huge act but three main points for today:– Increase in estate credit until 2010 repeal– Phase-out of tax brackets– Repeal of step-up in favor of modified basis

increase


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Sunset? Why?

• Sunset provision needed to comply with “Byrd Rule”

• Byrd Rule permits Senators to raise points of order against “extraneous” provisions such as a budget impact beyond period covered in the applicable reconciliation measure

• Can waive rule if have 60 votes• Republicans did not have 60 votes • So, Republicans choose sunset to avoid

implementation of the Byrd Rule


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Amount of Exclusion from Estate Taxes

• 2001 - $ 675,000• 2002 - $1,000,000• 2003 - $1,000,000• 2004 - $1,500,000• 2005 - $1,500,000• 2006 - $2,000,000• 2007 - $2,000,000

• 2008 - $2,000,000• 2009 - $3,500,000• 2010 – N/A: no estate

taxes• 2011 & after -

$1,000,000*

*(this is not a typo!)


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Phase-out of Tax Rates

Highest Tax Rate:

2001- 55% 2007-2009 – 45%

2002- 50% 2010 – N/A

2003 - 49% 2011 – back to 2001

2004- 48% so 55%

2005- 47%

2006- 46%


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Impact on Gift Taxes

• Credit for gift taxes does not change and is frozen at $1mm

• For 2010, the maximum gift tax rate is 35% - §2502

• After 2010, if sunset applies then back to pre-EGRRTA rules apply (linkage to estate tax system as a “unified system”)


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Generation Skipping Taxes

• GSTT exemption:– 2009 - $3,500,000– 2010 – N/A (no GST)– 2011 - $1,060,000 per sunset


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Partial Step Up in Basis

• Before EGTRRA– Assets subject to estate tax but basis in all

assets increased to market value on (§1014):• Date of death; or• Value on alternate valuation date (6 months after

death)

• EGTRRA “repeals” the estate tax laws and for decedents dying after 12/31/09, there is no more basis increase (§1014(f))


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Complicated Basis Rules

• Since step-up repealed, there instead is a modified carry-over basis (§1022)

• Subject to certain conditions:– General basis increase is an additional $1.3mm– Assets to surviving spouse can receive a $3mm

additional basis increase

• So, need to track the allocations and it can be very complicated series of computations

• This rule also sunsets as it is part of EGTRRA


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If Modified Rules Continue

• Estate planning documents (RLT and/or Will) should:– Direct representative to use discretion to allocate

basis increase to certain assets– Prefer allocation to:

• assets that are most likely to be sold in the future• assets, which if sold, would produce ordinary income rather

than long term capital gains

– Don’t allocate to:• assets that will, or are likely to pass to, charitable

beneficiaries


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Lot of Confusion

• What is going on?


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How to Plan?

• How does one plan?– Will the sunset of EGTRRA occur resulting in

a $1mm credit and full-step up in basis under §1014?

– Will there be a full permanent repeal with the “modified basis increase” (basically keeping 2010 in the future)?

– Will there be compromise legislation?


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Survey Says!

• Proposals:– Before the recent budget crisis thoughts of

permanent and full repeal– Now:

• Most seem to predict credit of $3.5 mm per person• Some predict credit of $2 mm per person• Top rate probably will be 45% • Possible portability of the credit from spouse to

spouse


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Senate/House Bills

• House passed on 12/3/09, H.R. 4154 (225 v. 200)– $3.5mm permanent exemption for estate & GSTT (not indexed)– Maintain $1mm exemption for gift taxes– Reinstatement of step-up in basis rules– 45% top rate for estate and gift taxes

• Senate is considering S. 2784– $3.5mm permanent exemption with inflation index adjustment– Credit is unified – applies to estate and gift taxes– 45% top rate for estate and gift taxes– Portability of unused credit

• Not exactly sure what will happen in reconciliation• Bottom line: amendment likely will be the one with “the

smallest possible amount of hissing”


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Timing of Change

• Back in 2001 conventional wisdom was for quick adoption

• Now, issue not priority and 2010 is approaching

• Best guess: change before first return for 2010 is due


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Retroactive Effect

• Initial reaction is for no retroactive effect– No ex post facto laws – Art I, Sect 9 of Cons

• However, per US Supreme Court:– Calder v. Bull (1798) – Art 1, Sect 9 applies to

criminal laws– U.S. v. Carlton (1994) – retroactive application of

amendment to estate tax code does not violate due process clause of 5th amendment unless since retroactive impact rationally related to a legitimate legislative purpose


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Where Go From Here?

• Lots of confusion• Plan for worst case

scenario:– Estate taxes with

$1,000,000 credit in 2011– A/B trust, unless both

spouses have less than $1,000,000 “for sure”

• May want to amend plan if estate tax repeal is made permanent


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A/B Trust – Slide I

• Avoid Pitfalls– Joint Ownership– Life Insurance– Retirement Assets– “I Love You Will”

• Problem with above is “wasted credit of first spouse”


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A/B Trust – Slide 2

• Goal:– Make sure that each

spouse can utilize applicable exclusion amount (unified credit)

• Pitfalls:– If do not implement,

then may only be able to utilize one spouse’s unified credit

– For instance, based upon credit in 2011 (if complete sunset) want to shelter $2,000,000 not just $1,000,000

– Savings: up to $435,000


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Family Trust

• Amount up to Estate Tax Credit

• Income and principal to spouse and children for (“HEMS”):– Health– Education– Maintenance– Support

• Spouse can be sole trustee


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Marital Trust

• Amount in excess of credit

• Income annually to spouse

• Principal for health, education, welfare of support of the spouse (“HEMS”)


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Why Should We Worry – We Have Less than $1,000,000 in Assets!

• Include:– Assets of both spouses unless A/B trust and retitling– Life insurance– Portion of jointly-owned property– IRA and other retirement plans– Household and personal effects– Collectibles– Assets in a revocable living trust

• Appreciation• Anticipated inheritances or gifts


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What if Assets > Both Credits

• If assets exceed the credits of both spouses then:– Consider ILIT– Consider CRT– Consider GRATs– Consider discounting & leveraged gifts– Other vehicles beyond scope, e.g., QPRT


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ILIT - Basics

• Purpose – insurance not taxed and can pay for taxes on remaining assets

• Watch out for three year rule

• Some flexibility in trustees but consider “reciprocal trust doctrine”

• Can incorporate dynasty trust provisions


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ILIT – Flexibility

• Trust protector provisions

• Possible to transfer insurance to new trust

• Possible to cancel policy and have new trust with different terms obtain new policy

• But be mindful of:– Fiduciary duties


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Charitable Remainder Trusts

• CRATs and CRUTs– Lifetime annuity or percentage to decedent

and/or spouse– Remainder to charity

• Large asset and appreciation removed from estate

• Income tax deduction


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Replace Lost Principal of CRT

- Purchase life insurance using cash generated from tax savings (income tax deduction)

- Own insurance in ILIT

- Best of both worlds – lot of assets out of estate, benefit charity and replace principal with no estate tax increase due to ILIT


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GRATs

• Retained annuity for the grantor• Remainder passes to beneficiary, e.g., children• Benefits:

– Annuity stream– Grantor taxed on income, i.e., grantor trust– Tax structure very clear as it is a statutory vehicle

(§2702(b))– Appreciation on trust property in excess of §7520 rate

(120% of mid-term AFR) is removed from estate if grantor survives the term

– Can “zero out” gift tax– Remainder removed from estate if survive term


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GRATs (Slide II)

• Disadvantages:– If die during term, value of the property

included (so, use series of rolling GRATs)– If survive annuity term, then annuity stops so

need to have replacement “stream” if Grantor needs same

– Discount or “hurdle” rate is higher than used in a private annuity or installment sale since 120% of mid-term rate not 100%


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Gifts

• Gift of assets using up estate tax credit

• Gift of assets using annual credit

• Future appreciation in the assets avoids estate/gift taxation

• Discounts may be available through FLP and other means


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Goals of Buy-Sell Agreements

• Provide a Market for Shares Upon Death of a Stockholder or Termination of Employment

• Restrict Transfer of Shares During Lifetime• Lock in the Value of Shares for Estate Tax

Purposes • Secure Successful Transition of Business

from One Generation to the Next


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Provide a Market for Shares

• Insurance proceeds – Death – Disability – Retirement or other termination of

employment - CSV


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Restriction on Transfer of Shares

• Desired sale to third party • Bankruptcy or divorce • Gift or pledge • Termination: For Cause and Not For

Cause • Death • Drag Along


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Lock in Value for Estate Tax Purposes

• Section 2703 of IRC and 2031• Avoid worst case scenario of valuation greater

than sales price per buy-sell agreement• Minimize audit exposure and avoid worst case

scenario• Save a lot of estate taxes and attorney fees • A lot of agreements do not sufficiently consider

this issue


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Six Requirements for Locking in Value (Req. 1 & 2)

• The estate must be obligated to sell the stock at the price set forth in the agreement. From 2031-2(h) and case law but not Section 2703.

• The agreement must be applicable to transfers during life. From 2031-2(h) and case law but not Section 2703.

(If not from §2703 then “presumption” for non-family buy-sells does not apply)


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Requirements for Locking in Value (Req. 3 & 4)

• Agreement must either fix a price or set forth a mechanism for its determination and the price must be fair and reasonable. From 2031-2(h) but not from 2703.

• Agreement must be entered into for a valid business purpose. From 2031-2(h) and set forth in Section 2703.


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Requirements for Locking in Value (Req. 5)

• The Agreement must not be a substitute for a testamentary devise. From 2031-2(h) and also set forth in Section 2703. Two Tests:

– Does the agreement serve a testamentary purpose?

– Was formula fair at the time when the agreement was entered into?


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Requirements for Locking in Value (Req. 6)

• Terms of buy-sell agreement must be comparable to similar arrangements entered into by persons in an arm’s length transaction. From Section 2703.


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Business Succession

• Who will inherit?

• Who should run the business? – Kids – Spouse – Creditors – Key employees


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Cross-Purchase Type

• Cross-Purchase – Increase in basis – Can be complicated if have more than three

or four stockholders: Each stockholder needs to own policy on life of every other stockholder unless:

• Possible to use LLC (but probably need to establish business purpose besides owning insurance)


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Redemption Type

• Stock Redemption – No increase in basis – Proceeds subject to creditors of the business– Possible AMT for non-small (§55(e)) C Corps

(ACE adjustment when paid)– Avoid potential dividend treatment if not

buying all shares – Probably easier to administer


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Transfer for Value Pitfall

• Recipient Generally Not Taxed On Receipt of Proceeds

• Exception that results in tax: If swap policies to start agreement or other transfer occurs

• Very easy to fall into this trap - even if co-own policies to reduce required number

• Potential solution if problem difficult to otherwise avoid: Have LLC own policies


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Who Pays Premiums?

• Recognize income tax issues

• Possible use of split-dollar funding arrangement where corporation pays premiums but shareholder owns all or portion of policy


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Who Owns Policy?

• If cross-purchase - shareholders need to own policies

• If redemption - company needs to own policies

• Possible use of split-dollar arrangement or LLC


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What Happens to Excess Proceeds?

• If don't pay attention – you are rolling the dice

• Generally, excess should be retained by owner of policy: corporation or other


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Summary – Buy-Sell

• Very important tool to consider even if estate and gift taxes are repealed

• But, must carefully consider all issues since there are many traps for the unwary


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Other Issues

• Powers of attorney:– Medical– Financial

• Living Will• Creditor Protection

Planning• Pour-over Will – appoint

guardians for children• Special Needs Trusts


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The End

12/15/09copyright 2009 scott dondershine1 estate planning concepts in an age of uncertainty scott...

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