Estate Planning Is in a Pressure Cooker!

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Not only has the IRS threatened to change the rules of valuing gifts, which will have a significant impact on many estate planning techniques used over the last several decades, the presidential elections will have a huge impact over whether the estate and gift tax law survives, or becomes extremely more expensive and complicated.

After an agonizing wait, the IRS issued Proposed Regulations on August 4th that will eliminate many of the valuation discounts applicable for family-owned businesses and wealth in general. These new rules will become effective thirty days after publication of final regulations, which are expected in the next 12 months.

That means gifts prior to the effective date of the regulations may continue taking into account all applicable valuation discounts and used over the last several decades, and those family business owners who postpone these estate planning techniques of transferring wealth to trusts for future generations will be hurt economically under the new rules. While we do not know for sure what the final regulations will say, the question is obvious, is any further postponement worth the risk?

Additionally, there is a substantial difference between the two presidential candidates’ tax policy proposals, particularly relating to the estate and gift tax. Donald Trump proposes to eliminate the estate and gift tax. Mrs. Clinton, however, proposes to reduce the estate tax exemption (which will be $5,490,000 in 2017) to $3,500,000 (per person) with no adjustment for inflation. She proposes to reduce the lifetime gift tax exemption from $5,490,000 (2017) to $1,000,000, with no adjustment for inflation.

This situation is reminiscent of the concern in 2012 when we feared the exemptions may go from $3,500,000 to $1,000,000. Many clients scurried to take advantage of estate and gift tax advantages before year-end. Those clients, by the way, are generally laughing all the way to the bank as not only have they moved significant wealth out of the gift tax system, but the statute of limitations on the IRS’ ability to review the substance of those transactions has just about expired.

Mrs. Clinton is not done there! She proposes to raise the current estate tax rate from a flat 40% to 45% on estates under $10,000,000, 50% for estates from $10,000,000 to $50,000,000, 55% for estates from $50,000,000 to $500,000,000, and 65% for estates for over $500,000,000. While this seems shocking, the maximum estate tax margin rates when I began practicing in 1976 was technically 77%!

Obviously, the double attack from the IRS and the potential Clinton Administration will raise havoc in the estate planning circles. Be ready to react relatively quickly as these proposals threaten to become reality.

For more information regarding this or any other estate planning concern, please contact us at 404-255-7400 or email us at info@hoffmanestatelaw.com.

The IRS is at it Again

michael w. hoffmanFamily Limited Partnerships (FLPs) and Family Limited Liability Companies (FLLCs) have long been used for a variety of purposes, including centralized asset management, creditor protection, efficient legacy planning, and implementing legitimate discounting and freezing techniques for estate planning purposes. Our estate and gift tax system relies on accurately determining the fair market value of the property being transferred. Fair market value is to be determined objectively considering hypothetical buyers and sellers. Appraisers must take into account valuation discounts for lack of control and lack of marketability. When property is transferred to descendants or trusts, the value of the particular property being transferred is what is reported for gift tax purposes, and then the property with all future appreciation is excluded from the grantor’s estate.

The IRS began a campaign of attacking FLPs back in 1997. Court decisions have generally rebuffed various tactics and positions taken by the IRS in the family limited partnership area.

The IRS publishes its priority guidance plan each year to emphasize areas of the tax law that the IRS may issue additional regulations. Additional regulations affecting valuations in an intra-family transfer context has been on the IRS’ priority guidance plan for the last 11 years. Now, it has been elevated to a proposal set forth in President Obama’s Administration’s 2013 Green Book. The IRS recently announced that it could issue proposed regulations as early as September, which would severely restrict valuation discounts for interests in FLPs and other family entities.

Articles are now appearing which are encouraging estate planners and clients to get ahead of these likely new rules. It is likely that the IRS position will be that any new rules will be effective upon the publication of the proposed regulations, even though they will not become “final” regulations until a much later date.

Earlier this summer, we sent messages to clients who are in the midst of their estate planning that they may want to expedite the process, before the IRS can issue proposed regulations which greatly curtail the legitimate discounting and freezing techniques that we’ve implemented with countless clients. One would think that only Congress can change the law with respect to re-defining the value of property for gift and estate tax purposes, but the Obama Administration has an historical edict of affecting change by more government regulation. The IRS, no doubt, is feeling very confident in their power to limit valuation discounts by way of their regulatory authority.

If you have put off further estate planning, time may be of the essence. If your planning should include the many benefits of FLPs and FLLCs, or if you have an FLP or FLLC and gifting may be appropriate, you may want to get with your advisor sooner, rather than later. If we can help, give us a call.

For more information regarding this or any other estate planning concern, please visit the Hoffman & Associates website at www.hoffmanestatelaw.com, call us at 404-255-7400 or send us an email.

Last Will and Testament

A Will is a basic estate planning document that provides for the distribution and disposition of property and personal assets of an individual after death.  A Will becomes effective upon death; therefore, it may be changed at any time prior to death.  It should also be periodically reviewed to be sure it applies to the maker’s current personal and family situation.  A Will may contain general or specific provisions regarding the care and distribution of property, the distribution of disclaimed property, recommendations for guardians of minor children, the appointment of executors to administer the Will and express desires and guidance regarding the administration of the estate.  Finally, the Will may establish trusts for the benefit of loved ones or charities and trustees to manage these trusts.

The design of our preferred Will for single-marriage clients creates two trusts at the death of the first spouse:  a Marital Trust and a Credit Shelter Trust.   At the death of the first spouse, the Credit Shelter Trust is funded with enough assets to capture the first-to-die spouse’s federal estate tax exclusion amount, and the remaining assets, if any, fund the Marital Trust.

The Marital Trust is funded with any amounts over the exclusion amount because the (100%) Marital Deduction allows an unlimited amount of assets to be transferred to a spouse upon death tax-free.  This structure provides for the benefit of both estate tax exclusions:  initially the federally-provided exclusion, whatever that may be in the year of death, and the marital exclusion for all assets above that amount.  Thus, no estate taxes are due at the death of the first spouse.

While it seems complicated, please keep in mind that the surviving spouse may have control over all of the assets of each Trust, as the Trustee of the Trusts, and would also be the primary beneficiary of the Trusts.

In the event one or both spouses are not U.S. Citizens, additional language must be added to the Will to ensure the couple receives the full benefits of the U.S. estate tax laws.

When children inherit property, we prefer a descendants’ trust created by the Will at the death of the second spouse.  This allows the assets to pass, in trust, to children and future descendants.  This format protects the assets from future estate taxes, creditor issues, divorce or other claims against the descendants.  The descendant, just like the surviving spouse above, upon reaching a certain age, may be the trustee of their trust and will be the primary beneficiary of his/her trust.

 

For more information regarding estate planning, business law or tax controversy and compliance, please visit the Hoffman & Associates website at www.hoffmanestatelaw.com or call us at 404-255-7400.

 

In accordance with IRS Circular 230, this article is not to be considered a “covered opinion” or other written tax advice and should not be relied upon for IRS audit, tax dispute, or any other purpose.  The information contained herein is provided “as is” for general guidance on matters of interest only.  Hoffman & Associates, Attorneys-at-Law, LLC is not herein engaged in rendering legal, accounting, tax, or other professional advice and services.  Before making any decision or taking any action, you should consult a competent professional advisor.

Federal Estate Tax Planning

In order to keep the estate tax burden from continually growing in your estate with further appreciation, you may want to do what many other clients have done: introduce some discounting and freezing techniques to your overall estate plan.  Gifting is also important, as each individual can make annual and lifetime gifts tax-free and decrease the size of his or her estate.

A popular freeze technique is where a client’s interest in limited liability companies, corporations, partnerships or real estate (the “Property”) is sold to a defective grantor trust (DGT) in exchange for an installment note. The beneficiaries of the DGT will be the client’s children and their descendants.  It is called a “defective” trust because the trust is a grantor trust, meaning the IRS ignores it for income tax purposes, but not for estate tax purposes (i.e., the grantor trust is “defective” for income tax purposes).

A DGT allows the value of the assets in such trust to be removed from your estates for estate tax purposes; however, the trust and any transaction(s) between the grantor (you) and the trust is disregarded for income tax purposes. For example, you would still pay income taxes on taxable income of the DGT.  This is a good tax result.  Your assets are being used to cover tax liabilities attributable to a DGT. This “tax haircut” is, in essence, gifting (paying someone else’s tax liability), but the IRS does not interpret this activity as gifting.

Your interest in the Property will be sold to the DGT in return for an installment note payable to you.  This will “freeze” the entire value of the Property; for estate tax purposes the unpaid balance of the installment note remains in your taxable estate, while the Property is not.  An income stream is generated for you from the DGT via payments on the installment note.  The payments from the DGT to you are ignored by the IRS since the payments are coming from a grantor trust.  The only “leakage” is the unusually small interest rate we are able to put on the promissory note to you. As discussed, payments on the installment note are typically interest only but we can work with that number based on the income and cash flow generated by the LLC property.  However, keep in mind that it is advisable to pay the interest yearly as the IRS may frown upon a balloon note with the interest and principal payable at the end of the term of the note.

The sale to the DGT allows you to not only freeze the value of the Property in your taxable estate, but to also reduce the size of your taxable estate based on the income taxes paid by you for the DGT’s income taxes, again, the “tax haircut”.  Also, you are able to take advantage of significant discounting in valuing the fractional LLC interests being sold to the DGT.

The non-voting membership interest in the LLC would be partially gifted and partially sold to the DGT in exchange for an installment note.  This way you freeze most of the value of the LLC in your taxable estate, but retain control of the LLC via your continued ownership of the voting membership interest. The underlying property in the LLC would need to be appraised.  The fees for these appraisals can vary depending on the appraiser.  Once those appraisals are received, the non-voting membership interest of the LLC would be valued.  After the non-voting membership interest is valued, we would use this number to determine the sale price for the non-voting membership interest.

For more information regarding estate planning, business law or tax controversy and  compliance, please visit the Hoffman & Associates website at www.hoffmanestatelaw.com or call us at 404-255-7400.

 

In accordance with IRS Circular 230, this article is not to be considered a “covered opinion” or other written tax advice and should not be relied upon for IRS audit, tax dispute, or any other purpose.  The information contained herein is provided “as is” for general guidance on matters of interest only.  Hoffman & Associates, Attorneys-at-Law, LLC is not herein engaged in rendering legal, accounting, tax, or other professional advice and services.  Before making any decision or taking any action, you should consult a competent professional advisor.

Musings from the CEO

In my last column, I discussed the current fate of estate and gift tax law.  The emphasis is on the prospective most significant increase in tax rates and lowering of individual exemptions that we have seen in our lifetime.  For those individuals with large estates, this creates a sense of urgency for estate planning to be done between now and the end of 2012.

Today, I’d like to bring it down a notch and discuss more traditional estate planning concepts that apply to a broader cross section of individuals/clients.

I am a firm believer in trusts, hence the moniker a “trust and estate lawyer”!  For the vast majority of our clients that means leaving their estates to their spouse, but directly to trusts that are created by their Wills.  These trusts are most often controlled by, and for the benefit of, the surviving spouse.  When property eventually goes to children, we believe that in most cases it is far more beneficial to have trusts created for your children, regardless of age, that will last for their lifetime.

If the document creating the trust (Will or trust agreement) is properly drafted, your spouse or child can be the trustee of his or her trust, effectively exerting all of the control over assets that they would have had if they inherited property outright.  However, the estate tax savings for future generations, the potential avoidance of generation skipping tax, the income tax flexibility, the protection from creditors, the protection from divorce, the preservation in the family, and the avoidance of probate are some of the reasons that it is desirable to allow the property to flow from generation to generation in trusts, as long as there are any significant assets worth protecting.

The 2010 tax law introduced the concept of “portability”.  This simply means that if one spouse dies and his or her estate does not use all of their estate tax exemption, the remaining unused portion can be carried over to the surviving spouse to be used in that estate.  There are numerous limitations and weaknesses in relying on portability, and we suggest that clients continue to have Wills that leave property to surviving spouses in trust(s), generally a combination of a Credit Shelter Trust and a QTIP Marital Trust.

Life insurance trusts are very common in many estate plans.  It almost always seems to be a good idea to get life insurance out of estates now.  As we get older, our clients acquire a lot of insurance for estate liquidity purposes.  If we maintain insurability, it is always good to have these policies reviewed to make sure that you are allocating resources as prudently as possible.  There may be situations where it would be prudent to prepay premiums.

Another method of reducing an otherwise taxable estate would be to consider a Roth conversion of a traditional IRA as a technique to get taxes out of a taxable estate, in a situation that would otherwise involve an asset (the traditional IRA) that will be subject to both income taxes and estate taxes upon the death of the owner.

Clients with more modest estates need to combine estate planning with Medicaid planning.  What can be done to protect assets if one of the spouses has to go into a nursing home?  First of all, both spouses should have a current Health Care Directive as a necessary part of their estate planning documents.  Considerations should be made to move investments to the name of the healthier spouse.  The healthier spouse’s Will can create a special needs trust in the event that he or she predeceases the spouse with health and living assistance concerns.

A part of estate planning should consider the need for long term care insurance.  The sweet spot to acquire long term care insurance seems to be when a couple is still in their 50’s.

The couple can consider a lifetime QTIP Marital Trust.  This would combine estate tax planning with Medicaid planning.  The lifetime QTIP is a method to protect the home in the event of Medicaid stepping in.  We also have a technique referred to as an Irrevocable Income Only Trust (IIOT) which can be established to start the five year look back rule for Medicaid.  Finally, once a spouse is moved to a nursing home, continued planning should be done for the independent spouse.

Besides Wills that create trusts for the surviving spouse and lifetime trusts for descendants, the Irrevocable Life Insurance Trust to remove life insurance proceeds from anyone’s taxable estate, the Health Care Directive, and any “special” trusts created for Medicaid planning, everyone should have a comprehensive General Power of Attorney.  These power of attorney forms should be “durable” so that the document remains in force after disability or incapacity.  In Georgia, these documents can be drafted so that they do not spring into effect until they are needed.

Remember that the more you plan, the more you save and the smoother the probate process will be for your loved ones.  The old adage is that “…we haven’t got an estate tax, what we have is, you pay an estate tax if you want to; if you don’t want to, you don’t have to.”

If you have any questions about estate planning, please contact Hoffman & Associates at (404) 255-7400.

June Letter from Mike

On January 1, 2013 (just 6 months from now), the estate tax and the gift tax exclusion is scheduled to be reduced from $5,120,000 to $1,000,000 per person.  That’s a decrease in the amount of property excluded from gift and estate tax of over 80%.  We are looking at  an increase in the estate tax rates from 35% to 55%, an increase of over 57%.

These tax changes are among the most significant that we will see in our lifetimes.  The potential effects on the number of people subject to a death tax and the amount of family wealth that will be transferred to the Federal Government is staggering.

Of course, we do not have a crystal ball.   We don’t know what the tax laws will be for sure next year, nor do we know what the situations will be 10 or 20 years from now.

What we do know is that for the last 18 months we have had a gift tax exclusion of  $5,000,000.  It jumped from $1,000,000 to $5,000,000 as a result of the mid-term elections and President Obama caving into Congressional pressure to reach a tax compromise in December of 2010.  There is a lot of “truth” to Professor James Casner’s statement to the House Ways and  Means Committee back in 1976,

“In fact, we haven’t got an estate tax, what we have is, you pay an estate tax if you want to; if you don’t want to, you don’t have to.”

What did he mean?  Those who properly and prudently plan, can all but eliminate gift and estate taxes.  Now it may mean that you have to start early in gifting property to your loved ones, but through proper planning and techniques, you may be able to retain almost complete control over the property conveyed.  It may mean that you’ll have to consider  whether you would like certain charitable organizations to spend your hard earned wealth, rather than the Federal Government.  This certainly is the choice of many well publicized billionaires, such as Warren Buffett and Bill Gates.  They are convinced that their charities can spend their money better than Congress and the President.

Gifting in 2012, for those who are able, is more attractive than ever before. The $5,120,000 personal exemption ($10,240,000 per couple) is scheduled to go away at December 31, 2012.  Therefore, there is a “use it or loose it” mentality.

We are coming out of one of the worst recessions since the Great Depression.  This has led to extremely low valuations on real estate and closely held business assets, which enhance the amount of property that can be given away through the use of exemptions and annual exclusions.

While the IRS has been attacking the use of valuation discounting, and lobbying for its elimination through  new legislation,  the ability to take advantage of marketability discounts and lack of control discounts generally reduces the value of property being gifted up to a third.

We are witnessing historically low interest rates.  In fact, the IRS published rate for June is a mere 1.2% (June’s mid-term rates are all 1.07%).  These low interest rates are very favorable for many estate planning techniques which are used in conjunction with gifting strategies.  These include grantor retained annuity trusts (GRATs), charitable lead annuity trusts (CLATs), and Sales to Defective Grantor Trusts.

All these favorable reasons for gifting, with the backdrop of rising taxes as soon as six months away from now, makes 2012 the opportune time to consider gifting.  Such planning takes time and analysis to do it right.  Therefore, it should not be left to the last minute.

Sincerely,

Michael W. Hoffman

 

If you have any questions regarding this letter, please contact Hoffman & Associates at 404-255-7400

The SCIN: An Attractive Estate Planning Opportunity In 2012

2012 presents unique opportunities to do estate planning.  The reasons may be familiar to you by now:   lifetime gift and estate tax exemptions are $5 million (without Congressional action, it will go to $1 million in 2013), valuation discounts for family owned entities remain viable, and property values and interest rates at all time lows.  The catch:   There’s a limited time to capitalize on these opportunities.

This article will focus on one estate planning tool, the Self Canceling Installment Note (“SCIN”) whose benefit is magnified under 2012’s low interest rate environment. 

What is a SCIN?

SCINs are a planning technique used in a sale of an asset to either a trust or directly from an older family member to members of a younger generation.  Basically, the older generation sells the asset in exchange for an installment note with a term shorter than the seller’s life expectancy.  Life expectancies are found in IRS tables.   The installment note contains a provision by which the remaining balance is completely canceled upon the seller’s death.

What is the benefit of the SCIN?

What makes a SCIN a valuable tool is the fact that if the seller dies before the term of the note, the remaining balance is completely canceled and this canceled amount is not included in the seller’s taxable estate.   

The SCIN is especially beneficial if only annual interest payments are made until the end of the term, when a balloon principal payment is due.  By deferring the principal payment until the end of the term, the amount cancelled upon death can include the entire principal amount of the promissory note.

To illustrate, assume a client sells a small business worth $10 million to a trust for her children in return for a promissory note with annual interest payments and a balloon payment at the end of the term.  This simple sale would itself be beneficial for estate tax purposes.  If the business  appreciated to $20 million before client’s death, all $10 million of appreciation would be outside the client’s taxable estate, perhaps saving $3.5 million in estate taxes.    However, $10 million remaining principal balance on the note would remain in the taxpayer’s taxable estate, subject to a 35% tax rate.  If the client had used a SCIN rather than a simple promissory note,   the $10 million principal payment would cancel, leaving the trust with a windfall.  For estate tax purposes, this means that the entire $20 million asset escapes estate tax.

Is there any downside to a SCIN?

The IRS would not allow this transaction unless it is equivalent to an arms-length transaction between unrelated parties.   So in return for the self cancelling feature of the note,  a “mortality risk premium” is charged to the payor – typically an increased interest rate.  The older the seller is, the greater the mortality risk premium will be.    

This mortality risk premium is the downside of the SCIN transaction.  If the seller outlives the term of the SCIN, the trust will have paid the mortality risk premium interest rate to the seller for absolutely no benefit.[1] 

What makes 2012 an unusually good time to use a SCIN?

What makes the SCIN extremely attractive now is the historically low interest rate environment.  The SCIN interest rate is the base AFR rate which the IRS requires for all promissory notes, plus the mortality risk premium.  

Today, both the AFR rates and mortality risk premiums are very low.   Long term AFR rates for 2012 have hovered around 2.75%.  The largest the mortality rate premium has been for a 55-year-old male since January 2010 was only .58 percent.  The SCIN rate for a 70 year old in March 2012 was only 3.07 percent.    Thus, a 55 year old can do a SCIN at an interest rate of around 3.47%.  A 70 year old can do a SCIN for a rate of around 5.96%.  In both cases, the SCIN interest rates are below historical average prime rate of interest for third party loans.    Under these circumstances the downside risk of a SCIN is very small when compared to the huge estate tax benefit that could result. 

If you need help with your estate plan or want additional information, please contact us at (404) 255-7400.


[1] This downside risk can be mitigated by combining the SCIN strategy with a GRAT strategy.  The SCIN strategy only works if the seller passes away during the term of the SCIN. The GRAT strategy only works if the seller survives the term of the GRAT.  By combining the two, mortality risk can be greatly reduced if not eliminated.

H&A Successful in another Estate Tax Audit

H&A has again successfully settled an estate tax audit.   In this case, the IRS confronted the Estate with an additional assessment of nearly $2.4 million dollars in estate taxes.  The IRS assessment was based largely on three issues.  First, the IRS argued that an LLC created prior to death should be included in the estate under IRC Section 2036.  Second, the IRS argued that a vacation home  previously owned by a QPRT and rented back to the decedent should be included in the decedent’s taxable estate under IRC Section 2036.  Finally, the IRS disallowed an estate tax deduction for interest on a Graegin loan taken from the recently created LLC to pay estate taxes.

H&A was able to successfully defend the Estate on each and every issue on which the IRS based its assessment. Through proper planning, creative thinking, and hard work by H&A, the Estate recently received from the IRS a no-change closing letter.  This was a collaborative effort across all firm departments, and is a testament to the wide ranging skills and knowledge offered to our clients.   I’d like to thank everyone involved for their efforts in bringing this matter to a successful conclusion.

We cannot guaranty similar results, as success or failure of any audit defense depends on the facts and circumstances of the individual case.  If you need help dealing with the IRS, please do not hesitate to contact us at (404) 255-7400.

2011/2012 Federal Estate, Gift and Generation Skipping Transfer Tax Update

December 2010 turned out to be an exciting month for estate and gift tax laws.  On December 17, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the “Act”).   The Act sets forth an exemption amount of $5,000,000 for federal gift, estate and generation skipping transfer taxes for years 2011 and 2012. In addition, the Act sets the top tax rate at 35 percent.  The Act further provides for portability between spouses in 2011 and 2012 to utilize the unused estate tax exemption amount of the first to die of the spouses if the second spouse dies before 2013. 

Since this Act is only good for 2011 and 2012, if Congress fails to act to extend this current law, the federal gift, estate and generation skipping transfer tax exemption amount reverts back to $1,000,000 and the top tax rate of 55 percent returns. 

With this two year Act, there are many planning opportunities.  Obviously, individuals can gift up to $5,000,000 without any federal gift taxes.  Gifts can be made to a grantor trust (which means the trust income is attributable to the grantor rather than the trust) that allows the gift to grow without incurring income taxes.  In the alternative, an individual can purchase a significant amount of life insurance coverage inside a life insurance trust utilizing the increased gifting exemption of $5,000,000 which can then pass free of probate, income and estate taxes to future generation. 

Because the Act is only temporary, it is a good idea to review your current estate planning documents to make sure it stills accomplishes the goal desired.

Governor signs Senate Bill 461

Governor Perdue signed Senate Bill 461 on May 28, 2010, making the provisions thereof retroactive to January 1, 2010.  As discussed, the law allows married Georgia residents to utilize the entire step up in basis provided under the current estate tax laws without modification to current documents.

If you have any questions about this law or how it affects your estate plan, please give us a call.

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