Specialized Estate Planning Techniques

KRH Website PictureThere are several areas of estate planning that provide unique opportunities to enhance tax and succession planning, while ensuring proper dissemination of net worth to appropriate individuals and/or entities.  Below are summaries of some of these specialized estate planning techniques:

INSURANCE

People should be aware that many estate planning situations involve the strategic use of insurance products.  Many attorneys and CPA’s often fail to see the connection between the dynamics of insurance and estate planning.  Individuals purchase millions of dollars worth of insurance each year for estate planning purposes, including liquidity, wealth replacement and business succession reasons.  Life insurance has relatively little market value during the life of the insured, therefore it is easy to get these policies isolated into an irrevocable life insurance trust.  Otherwise, the death benefit will be subject to the confiscatory estate tax.

DYNASTY TRUSTS

A Dynasty Trust is actually an irrevocable trust created by a trust agreement that may continue to create and operate trusts for many successive generations.  The trusts can continue passing assets from generation to generation without incurring transfer taxes.  Advantages of a Dynasty Trusts include estate tax-free compounding, creditor and divorce protection, per stirpital control, avoiding probate and potential income tax savings.

Most states have rules against holding property in trusts forever and limit the duration of the trust.  For example, Georgia allows trusts to continue for 90 years.  Fortunately, some states have abolished, enacted opt-out provisions or made other changes to their “rule against perpetuity” statutes allowing a person to create trusts to continue forever.  Currently, these states are Alaska, Arizona, Colorado, Delaware, Idaho, Illinois, Maine, Maryland, Missouri, Nebraska, New Jersey, Ohio, Rhode Island, South Dakota, Virginia and Wisconsin. In addition to these states, Wyoming and Utah both allow Dynasty Trusts to last for 1,000 years, Florida allows  Dynasty Trusts to last for 360 years and Washington allows Dynasty Trusts to last for 150 years.

Ironically, a person does not have to live in one of these states to take advantage of its laws. The Dynasty Trust language would name a special trustee that resides in the jurisdiction so desired to hold and manage the trust assets, thereby giving the trust sufficient nexus to the state in order to utilize its laws.

FAMILY LIMITED PARTNERSHIPS

Family Limited Partnership (“FLP”) is a business entity set up to hold assets such as stock, real estate, etc.  Actually, in certain circumstances, limited liability companies (LLC’s) or limited liability limited partnerships (LLLP’s) may be the entity of choice, but the planning technique is generally referred as an FLP.

Transferring assets to an FLP can result in gift tax and estate tax savings because the taxpayer now owns a limited partnership interest rather than the underlying assets.  Limited partners, under common law, state law and the partnership agreement cannot participate in management or generally force liquidation of the partnership; therefore, the value of the partnership interest in an arms-length transaction is affected by a lack of control discount.  There also may be restrictions on transferability and other reasons that the limited partnership interest is worth less than a proportionate share of the underlying assets that are inside the partnership.  Therefore, gifts of partnership interest have become very popular ways of diminishing the size and growth of our clients’ estates.

Other advantages of FLP’s are the power to monitor wealth transfers to heirs, simplification of a person’s annual gifting, keeping assets in the family, providing creditor protection, protecting family assets from failed marriages, flexibility in the partnership agreement (as opposed to the irrevocable, unamendable trust), and flexibility in the management of the FLP. However, there are many formalities that must be followed in setting up FLP’s.  For example, the IRS requires significant non-tax purposes for the FLP.  There are a myriad of guidelines that should be followed, such as one should not transfer “personal” assets, like a personal residence, to an FLP.  FLP’s are a great tool to pass a client’s wealth on to the heirs during their lifetime, while  minimizing gift and estate taxes.

DEFECTIVE GRANTOR TRUSTS

A Defective Grantor Trust (“DGT”) is a term used for a trust that effectively removes property from a grantor’s estate for estate tax purposes, but not for income tax purposes.  A DGT is often used as a “freeze” technique, particularly for clients with large holdings of S corp stock.

S corp stock cannot be transferred to limited partnerships because a partnership is not a permitted S corp shareholder.  Yet, one of our objectives is often to try to shift any future appreciation in the S corp to a dynasty trust that has been set up for future generations.  A DGT is a permitted S corp shareholder. The grantor sells his/her interest in the S corp to the DGT (with dynasty provisions) in exchange for an installment note.  Because a grantor is considered owner of the DGT for income tax purposes, this sale is ignored for IRS purposes (no gain recognized).  We have now moved this asset out of grantor’s estate, except for the monies paid to him/her resulting from the installment note.

We have used a self-canceling installment note (“SCIN”) with an installment sale to a DGT.  This is obviously attractive since any remaining value of the installment note will go to zero if the grantor dies before the note has been completely paid.

GRAT’s, CRT’s & QPRT’s

Grantor Retained Annuity Trusts (“GRAT”), Charitable Remainder Trusts (“CRT”) and Qualified Personal Residence Trusts (“QPRT”) are irrevocable trusts where the grantor transfers an asset to the trust in exchange for an annual payment (or use of the underlying property in the case of a personal residence trust) for a specified term of years (or for life in the case of a charitable trust).  Upon the expiration of the term the trust terminates and the assets pass to the named beneficiaries or charities.  Due to the current low interest and tax rate environment, techniques involving GRAT’s can be more attractive, while generally CRT’s and QPRT’s are not as popular, but they all are still used in particular situations.

On the other hand, CRT’s may be more popular for their income tax advantages.  Assets are first contributed to the CRT and then sold.  Generally, 100% of the proceeds are then available for alternate investments.  The CRT is a device that can be used to alleviate income taxes on the sale of capital assets because CRT’s are generally not subject to income taxes. Presently, the low interest rate environment maximizes the amount of charitable deduction that is available for gifts to CRT’s today (versus several years ago.  However, the capital gains rates have generally been reduced to 15% making the avoidance of these lower rates less attractive.

A popular variety of the GRAT planning technique is the “Walton” GRAT.  This is a very short term GRAT used to remove appreciating property out of an estate with zero or minimal gift tax consequences.  The Walton GRAT sets up the payment to the grantor over a short period of time where the GRAT will exhaust most of the corpus within the trust.  Since, according to the IRS tables, the value returned to the grantor represents the entire value of the trust, the gift element (the remainder interest) is worth nothing for gift tax purposes.  However, the appreciation in the property that has occurred over that period of time is removed from the grantor’s estate.  A Walton GRAT is particularly useful if the value of the asset placed in the GRAT is a discounted asset, such as a limited partnership interest.  A limited partnership can make distributions to the GRAT during its term and allow payments back to the grantor, while having the limited partnership interest flow to dynasty trusts at the end of the GRAT’s term.

These are merely a few of the examples of the types of unique estate planning techniques available to estate planning clients.  It is important that clients, attorneys, accountants, trust officers, insurance agents and financial advisors become familiar with these techniques so they can be watchful and vigilant for opportunities where they may be appropriate.

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.

 

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 (Summer 2013)

Late last year many of our clients were scurrying around to do some last minute gifting.  The fear was that the $5,000,000 gift and estate tax exemption would fall back to $1,000,000; therefore, the opportunity to remove a significant amount of wealth from their taxable estates (and the future appreciation on such property) would be lost forever.  Ironically, or typically, after the 12th hour (at approximately 2 a.m. on the morning of January 1, 2013), Congress passed a new tax law making the $5,000,000 exemption permanent and increasing the tax rate from 35% to “only” 40% (as opposed to the anticipated 55%).  Congratulations to those who completed these estate planning maneuvers, as their families will benefit for generations to come from their, albeit maybe last minute, action.

Under the heading “here we go again”, on April 10th, the Obama Administration published their annual wish list of 2014 revenue proposals.  Several of the provisions related to estate planning, including, are you ready for this, changing the estate and generation skipping transfer tax exemptions back down to $3,500,000, and the gift tax exemption to $1,000,000!  The proposal includes another increase in the tax rate to 45%.  Additionally, the Obama Administration proposes to limit and curtail the use of GRATs (Grantor Retained Annuity Trusts), the technique of gifting or selling assets to a grantor trust, limiting the duration of exemption from generation skipping transfer tax to 90 years (as opposed to unlimited dynasty trusts in some parts of the country), and requiring the reporting to the IRS of purchases of life insurance in excess of $500,000.  As President Reagan said so succinctly, “There you go again!”.

One message is clear.  For those of you that embarked on significant estate planning back in 2012 and prior, congratulations.  For those of you who did not, and who need it, giddy-up!

Enough about estate planning.  The American Taxpayer Relief Act of 2012 (which became law on January 2, 2013), and the Patient Protection and Affordable Care Act of 2010 (“Obamacare”) both become effective in 2013. Therefore, we will be spending a lot more time doing income tax planning.  The classic strategies of maximizing your deductions, reducing ordinary income, trying to achieve long term capital gains versus ordinary income, accumulating tax exempt income, deferring taxes and offsetting income with losses all need to be reviewed and expanded.

For high income taxpayers, up to 80% of itemized deductions can be lost.  For high income taxpayers, tax rates will exceed 39.6%, and combined with state income taxes could easily exceed 50%.  For high income taxpayers, dividend and capital gains rates increased 1/3 from 15% to 20%.  For high income taxpayers, the personal exemptions will be phased out and there will be a Medicare surtax on investment income of 3.8% and on earned income of .9%.

Income taxes have taken a sharp increase, deductions are being reduced, and the level of your adjusted gross income is critical to proper planning.  Be prepared to immerse yourself into these new income tax matters between now and the end of the year. For a lot of us, the tax savings or costs will be very significant.

 

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.

Procrastination: What Are The Consequences?

Currently, there are approximately 70% of Americans without a Will.  Without this basic estate planning document, your loved ones may pay the highest possible taxes upon your death, lose some of the assets you have earned during your lifetime, and will have to handle a much more complex administration of your estate.

By way of example, consider these famous deaths: Elvis Presley died suddenly at the age of 42 with an estate worth an estimated $10 million.  Of that amount, his daughter only received $3 million, as the other 70% was spent on estate taxes, administration costs and legal fees.  With a proper estate plan, Elvis’ daughter certainly would have received more than a mere third of her father’s wealth.

Famous for their chewing gum, the Wrigley family is another great example of a missed opportunity.  Both of William Wrigley’s parents died in 1977.  Their death gave Mr. Wrigley controlling interest in the Wrigley company, but it also left a significant estate tax burden due to the IRS.  The Wrigley’s had to sell their 80% stake in the Chicago Cubs for $20.5 million in 1981 to satisfy this debt.

Finally, Steve McNair, the famous NFL MVP, died in 2009 with an estate estimated to be worth $19 million but without even a simple will.  In attempts to settle his estate, his wife tried to sell his interest in a Nashville restaurant, his ranching and farming business as well as his Nashville home.  Not only did his murder shroud any hope of a amicable resolution of his estate, but the lack of any planning whatsoever left his wife and his children in a heated legal battle over the estate assets.

Although the most basic tenet of estate planning is a Will, the estate plan may and should encompass other aspects of your financial situation for when you pass.  Estate planning is thoughtful foresight that protects your family, provides for their future, and makes your wishes known.  If you pass without a Will in place, your assets will be distributed in accordance with State law in a process known as intestate succession.

Under the intestate succession laws in Georgia, a personal representative of the deceased is appointed by the Probate Court in order to marshal the assets, pay the debts and then distribute anything left over to the heirs.  Heirs are the closest relatives of the deceased, including the spouse, if living, and the children, including adopted and those born out of wedlock.  Stepchildren are not heirs.  Heirs of other degrees are determined if necessary.  A determination of the heirs is made by the Court, while your estate pays court fees, lawyer fees and other costs associated with probate handled by the Court and state law, rather than pursuant to your directions set forth in a Will. The Court and personal representative (which may or may not be a family member) may charge hefty fees (sometimes 5-15% of the value of the estate) to administer your estate.  Above all, this process takes time.  The probate of an estate handled by the court may take months longer than if you had clear, specific instructions regarding the distribution of your estate in a Will.

Having a Will does not avoid the probate process; rather, a Will is followed by the Court to determine who receives what property, who is appointed guardian of any minor children and who will be responsible for carrying out the wishes contained in the Will.

In order to ease the administrative burden on your family at your death and to save time and money on court costs and fees, you should plan accordingly now by contacting professionals who can help, such as an estate planning attorney, a financial planner, a CPA, and an insurance agent.  All can work together to help you prepare a plan that fits your family’s needs.  An exhaustive plan put in place by each of these professionals can also ensure you are taking advantage of any and all tax savings’ tools available to you.

Consider the following goals when thinking about your estate plan:

  • Determining who receives what share of your assets.
  • Deciding who will manage your estate and be responsible for distribution of the assets.
  • Selecting a guardian for your children.
  • If you own or control a business, providing for a smooth transition of management into the hands of persons who will effectively manage the business.
  • Arranging your affairs so that the chance for disputes among your heirs is minimized.
  • Making sure that your heirs can live with the estate plan. A plan that cannot respond to changes in the economy, or to unanticipated events, can burden the family.
  • For individuals with charitable wishes, making sure that your vision will be fulfilled.

With these overall goals in mind, it is important to move forward in developing an estate plan that fits your family’s needs.  At Hoffman & Associates, we define a basic estate plan as having the following essential components:

For individuals and families who are of higher net-worth, additional planning techniques may be introduced in order to reduce the estate taxes due upon death and take advantage of other tax savings strategies during your life.  Some of these techniques include:

 

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.

SELF-CANCELING INSTALLMENT NOTE (SCIN)

The Self-Canceling Installment Note (“SCIN”) is a planning technique usually used in a sale of an asset to either a trust or directly from an older family member to a member or 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, which is found in Internal Revenue Service (IRS) Tables.  The SCIN is a valuable tool because, if the seller dies before the term of the note, the remaining balance is completely canceled and is not included in the seller’s estate.

The SCIN is best structured as requiring interest-only annual payments until a balloon principal payment is due at the end of the term.  By deferring the principal payment until the end of the term, the amount canceled upon death will include the entire principal amount of the promissory note.

Of course, the IRS would not allow this transaction without a modification of the terms of the note to make it an arms-length transaction between the parties.   So, either the principal amount or the interest rate must be increased to make this a bona fide transaction.  The older the seller is, the greater the mortality risk premium will be.  However, with long-term interest rates being at historical lows right now, the time has never been better for an estate-freezing transaction using a SCIN.

For example, using October’s rates, a 55-year-old person could sell assets using a 28-year SCIN with a balloon payment and an interest rate of only 2.695%.   If the seller died before the end of the term, the value of the entire principal amount would be transferred to the trust without incurring any estate tax.

These low rates make a SCIN not only a good idea for clients looking to freeze some of the value of their estates, but there is also opportunity for clients who have already entered into DGT sales (see other articles on website that describe DGT sales as a popular estate planning/freezing technique) to refinance with a SCIN, possibly at lower rates and the self-canceling feature.

 

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.

Grantor Retained Annuity Trust (GRAT)

Another advanced estate planning technique is known as a grantor retained annuity trust (a “GRAT”). GRATs  are created by transferring one or more high yield assets into an irrevocable trust and retaining the right to an annuity interest for a fixed term of years or for the shorter of a fixed term or life.  When the retention period ends, assets in the trust (including all appreciation) go to the named “remainder” beneficiary.  In some cases other interests, such as the right to have the assets revert back to the transferor’s estate in the event of the transferor’s premature death, may also be included.

GRATs provide a fixed annuity payment, usually based on a fixed percentage of the original value of the assets transferred in trust.  For example, if $500,000 is placed in trust and the initial annuity payout rate is 6%, the trust would pay $30,000 per year, regardless of the value of the trust assets in subsequent years.   If income earned on trust assets is insufficient to cover the annuity amount, the payments will be made from principal.  Therefore, the transferor is assured of steady consistent payments throughout the term of the GRAT.    At the same time, all income and appreciation in excess of that required to pay the income beneficiary is accumulated for the benefit of the remainder beneficiary free of gift tax and without using the transferor’s lifetime gift tax exemption.

 The gift tax value of the transferred assets is determined at the time the trust is created and funded by subtracting the value of the annuity interest from the fair market value of the assets transferred to the trust.   The annuity interest is generally valued based on the 7520 rate published by the IRS.    Therefore, if the return on the GRAT assets over the term of the GRAT is greater than the 7520 rate, it may be possible to transfer assets to the remainder beneficiary when the trust terminates that far exceed the gift tax value of the transferred assets.

The one drawback of a GRAT is that GRAT assets will be included in the transferor’s estate if he/she passes away during the term of the GRAT.  Therefore, the GRAT is a bet to live strategy – the transferor is betting that he/she will survive the term of the GRAT to reap its estate and gift tax benefits.

There may be other non-tax reasons to form a GRAT as well.   A GRAT can help you ensure succession. For example, if a client wants specific assets, such as stock in a closely held corporation, other business interest, land, or family compound to go to one child rather than another, or the client does not want a former spouse, creditor, or someone who contests his/her Will to be able to obtain that asset, a GRAT can be used to implement such a contingency.

 

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.

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

GRAT Examples

Example of GRAT valuation:

$1,000,000 trust with grantor receiving a $50,000 annuity for 10 years. If the section 7520 rate is 3.2%, the value of the grantor’s retained interest is $396,260 and the remainder is valued at $609,740.

  •  So the right to receive the $50,000 annuity for 10 years is worth $396,260 and the right to receive the remainder at the end of the 10 years is worth $603,740.
  • The value of the remainder interest ($603,740) would be subject to gift tax upon creation of the GRAT.

Example of a qualified payment in a GRAT:

Grantor transfers 100 shares of X Company to a 3 year GRAT. The terms of the trust stipulate that the trustee must pay the grantor an annuity equal to 10% of the initial value of the trust in the first year with the annuity payment increasing 20% in the second year and 20% third year. After the third year the trustee is to distribute the remaining trust to the beneficiary.

Example of how a valuation formula will reduce the risk of unexpected gift tax consequences when dealing with hard to value assets:

Grantor transfers 100 shares of X Company to a GRAT, X Company has 200 shares outstanding and a company value of $1,000,000. Under terms of the GRAT, grantor retains an annuity of 15%, increasing by 20% annually, for 5 years, with the remainder interest going to his beneficiaries. Grantor files a gift tax return showing a transfer of $300,000 to the GRAT ($1,000,000 x 50% ownership minus 40% discount), with a gift of $44,872.50 to 3 beneficiaries. If on audit the IRS only allows a 20% discount, the taxable gift would be $59,830. Thus, an increase in the amount transferred by $100,000 increases the taxable gift by approx. $15,000.