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.

Legal Matters in Starting Your Business

Mike_Hoffman_17Join Mike Hoffman in this 74 minute audio as he hosts the 11th session of the 24 hour MBA in discussing how to get your business off the ground.  There are many different legal options in starting a business, and in this audio session, you will understand the best way to start your business and keep it successful for future generations.  24hrmba-11.mp3

 

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.

Family Limited Partnership (FLP) and Limited Liablity Company (LLC)

A family limited partnership or a limited liability company can provide important tax and non-tax benefits. From a non-tax standpoint, these entities are important in that they can provide a vehicle for managing family assets and can protect you from liabilities arising in connection with the assets held in the FLP or LLC. It can also provide asset protection, in that a creditor who might successfully seize the partnership interest from you will succeed only to your distribution rights, and may not be able to force a liquidation of the partnership (making it a much less attractive asset to seize.) Thus, a FLP or LLC is an excellent way to own buildings or an unincorporated business. From an income tax standpoint, a FLP or LLC can be superior to a corporation because there are no federal income taxes, and minimal or no state income taxes, on the income.

From a gift and estate tax planning standpoint, a FLP or LLC can give rise to significant valuation discounts. If a person owns a percentage interest in a FLP or LLC, the value of that interest will be less than the same percentage of the value of the net assets of the partnership. For example, assume that a FLP owns assets worth $100,000, and you own 10% of the partnership. Generally, your interest would be worth less than the $10,000 you’d receive if the partnership terminated and distributed the assets to the partners. That’s because you probably can’t force the partnership to terminate and distribute the assets. Rather, you’re entitled only to whatever distributions the general partner of the FLP or manager of the LLC elects to make. Typically, discounts from “liquidation value” will range from 15% to 40%, depending on the facts of the case.

If you make gifts of interests in a FLP or LLC, the value of the gift is based on the rights that the recipient has in the interest. Thus, the more power you retain in the partnership (and the less power the recipient has over the partnership), the smaller the value will be for the gift. On the other hand, on your death, the value of the asset in your estate will be based on the rights you’ve retained. Thus, the more power you retain in the partnership (and the less power the recipients of gifts you’ve made have received), the greater the value will be in your estate.

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.

Asset Protection: You Get What You Pay For

As estate planning, tax and business lawyers, we are always concerned with asset protection.  Whether we are talking in the context of trusts for surviving spouses or descendants, or protecting personal assets from business hiccups, asset protection is at the front of our minds when advising clients.

Asset protection comes in all shapes and sizes, from the simple to the ultra complex. Rules can vary significantly from state to state. Generally speaking, if you want to protect an asset, don’t own it!  Strategies can range from the simple professional who puts his or her home in their spouse’s name.  In debtor oriented states like Florida, it could mean owning that residence jointly as tenancy by the entirety, which protects the property from creditors of each spouse.  Titling property correctly is simple and inexpensive.  Of course, once you have transferred that property to your spouse, it may be difficult to get it back!

Traditionally, businesses have conducted themselves as corporations or similar entities, one reason being to isolate the business activity from other assets owned by the business owner.  For instance, if a corporation were to get a judgment against it, the creditor’s only recourse would be against the assets of the corporation.  The creditor would not be able to reach through the entity and get at the other assets of the owner.  This is one of the reasons that our clients traditionally do business as corporations, LLCs or limited partnerships.  All of these entities have the characteristic of limited liability.

However, if it is the owner who is the subject of a judgment creditor, he can lose his stock in his closely held business.  So, consider placing assets in a limited liability company.  Some jurisdictions (not Georgia) provide that a creditor’s sole remedy, with respect to the LLC ownership by a debtor, is to obtain a charging order.  This remedy permits the creditor to stand in line to receive any distributions from the LLC that would otherwise go to the LLC’s owner (the debtor);  but the creditor cannot take the owner’s membership units or foreclose on ownership interest.  This, of course, is not a popular remedy for creditors.  Creditors would prefer to control the ownership interest in the business, allowing them to sell assets or otherwise liquidate the business in order to satisfy the debt.  Charging orders as a sole remedy are a statutory rule in a number of jurisdictions including Florida (for multiple member LLCs) and Nevada (a jurisdiction we find ourselves using more and more for the clients whose primary motivation is asset protection).

Creating a corporation is more expensive than merely titling assets in the name of your spouse.  Forming an LLC is significantly more expensive than forming a corporation.  Forming an LLC in another state is somewhat more expensive on the front end and annually than forming a Georgia entity.  You get what you pay for.

The next level of asset protection brings us to the area of trusts.  Of course, you can form an irrevocable trust for the benefit of another, and if properly drafted, that trust can own property which is protected from the grantor’s creditors.  However, Georgia does not recognize what are referred to as “self-settled” trusts;  one cannot create a trust for his or her own benefit in Georgia and many other jurisdictions.  There are approximately a dozen states that do recognize some sort of self-settled asset protection trusts that can accommodate the grantor as a possible beneficiary of the trusts.  Again, of the dozen or so states that allow what are referred to as “domestic asset protection trusts”, Nevada would have to be at the top of the list.  Domestic asset protection trusts require an independent trustee, meaning that the grantor cannot be in total control of the trust assets, although total control would not have to be given to the third party. Significant management control could be retained by the grantor if the trust agreement is carefully drafted.  These arrangements are significantly more expensive than forming an LLC for asset protection purposes.  Generally speaking, the more protection one seeks, the more expensive it is to set up the structure and maintain it.

Other trusts provide asset protection characteristics.  For instance, it is possible to create a trust for the benefit of one’s spouse, and the assets in the trust would be protected from not only the grantor’s creditors, but also the spouse’s creditors.  The grantor is entitled, in essence, to control the disposition of the trust upon the demise of the spouse.  Again, this arrangement must be carefully drafted, particularly if husband and wife are creating trusts for each other.  Again, the grantor should not retain total control of the trust’s property, so a third party trustee is highly recommended.  These types of arrangements tend to be more expensive than the domestic asset protection trust.   There are numerous other trust arrangements that offer asset protection; the appropriate choice depends on the actual circumstances and objectives.

Trusts can also be established in foreign jurisdictions where the local laws with respect to taxes, statute of limitations and contracts are very favorable as deterrents to creditors.  Again, offshore trusts have been around for hundreds of years.  Popular jurisdictions include the Cook Islands, Nevis, Bahamas, Cayman Islands and a number of other Caribbean island countries.  These trusts have been romanticized for many years. They are most popular with liquid investment assets. These arrangements tend to be the most expensive types of asset protection devices, so they also tend to be rare.

Finally, no one arrangement is absolutely perfect.  Ownership transfers should occur prior to the time a liability or potential judgment appears.  Creditors’ lawyers can always argue that assets were transferred in an attempt to defraud particular creditors, therefore seeking court intervention or set-aside.  However, prudent and timely planning should always be better than no planning, even if the result is that creditors are more receptive to sitting down to negotiate more favorable terms with our clients.

 

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.

A Sole Remedy Charging Order Statute May Not Offer Debtors the Protection It Once Did

A charging order is a mechanism that allows a creditor to place a lien on a debtor’s interest in a partnership or LLC. When the partnership or LLC makes any distributions to the debtor, the creditor gets paid instead. If the debtor sells their interest, the creditor receives the sale proceeds. Ordinarily, the creditor cannot exercise the charging order to get the assets of the partnership or LLC, but a recent case in California may change all that.

A lawyer in a California case got a charging order against a debtor’s interest in certain partnerships, then he appointed a receiver for the debtor (a receiver basically has all the powers of a debtor). The debtor in this case had controlling interests in the partnerships and the receiver used the debtor powers to force distributions from the partnerships that were then collected by the charging order. The implications from this case are clear: Holding controlling or managing interests in a partnership or LLC is an open window for creditors to draw on assets.  If you have an LLC or partnership and desire charging order protection, it is better to let someone else have controlling or managing interests in the entity.

For more information or to discuss making changes to your LLC or partnership, please contact Hoffman & Associates at 404-255-7400

Defined Value Gifting Validated in Wandry v. Commissioner!

Hoffman & Associates has used defined value gifting as a way to reduce valuation risk in gifting hard to value assets since the early 1990s.   The idea is that a taxpayer should be able to gift a defined value amount of an asset rather than a fixed percentage of an asset.  

The IRS has long contested the use of defined value clauses as against public policy because they reduce the IRS’ incentive to contest asset valuations.  In the case of Joanne M. Wandry, et al. v. Commissioner, T.C. Memo 2012-88 (March 26, 2012), the Tax Court took the defined value gift issue head on and found the IRS arguments unpersuasive.

Mr. and Mrs. Wandry owned LLC units of Norseman Capital, LLC.  An independent appraiser determined that the  value of a 1% interest in the LLC was worth $109,000.  Mr. and Mrs. Norseman desired to gift to their children and grandchildren defined value amounts of the LLC as follows:

Name

Gift Amount

Kenneth D. Wandry

$261,000

Cynthia A. Wandry

$261,000

Jason K. Wandry

$261,000

Jared S. Wandry

$261,000

Grandchild A

$11,000

Grandchild B

$11,000

Grandchild C

$11,000

Grandchild D

$11,000

Grandchild E

$11,000

Total Gifts

$1,099,000

 The Wandrys executed assignments to their children and grandchildren with defined value amounts and containing the following adjustment clause in case the IRS later found that the LLC was improperly valued by the appraiser:  “the number of gifted [LLC] units shall be adjusted accordingly so that the value of the number of units gifted to each person equals the amount set forth above”.

In the years following the gifts, the Wandrys’ gift tax returns and the LLC income tax returns reported the children and grandchildren as an owner of a percentage of the LLC.  So each child reportedly owned a 2.39% ($261,000/$109,000) and each grandchild reportedly owned a .1% ($11,000/$109,000) interest.  

Years later, the IRS audited the gift tax return and found that a 1% LLC interest was, at the time of the gift, actually worth $150,000.   The IRS disregarded the defined value clause in the assignment, arguing that it is against public policy because it’s enforcement would virtually eliminate the incentive for the IRS to audit valuations of gifted property.  The IRS concluded that because the tax returns reported that the children owned a 2.39% interest, that must be the amount gifted to them.  And if a 2.39% LLC interest was gifted, then the value must be $385,500 (2.39% x $150,000) rather than $261,000.   The result of the audit was a taxable gift in excess of the Wandrys remaining lifetime gift tax exemption.

Mr. and Mrs. Wandry and the IRS eventually stipulated that a 1% interest in Norseman was worth $132,000, but the issues of whether the defined value formula clause and the adjustment clause were enforceable went before the Tax Court.  The IRS argued that the gift tax returns and the income tax returns were admissions of the transfer of fixed percentages.  It also argued the adjustment clause was void for federal tax purposes as against public policy on the grounds that it was a condition subsequent to completed gifts.  The taxpayers argued that the assignments only transferred defined value amounts (not percentages) and that public policy concerns regarding the adjustment clause did not apply because the value was set on the date of the gift.  

The Court found that the taxpayers’ intent and actions proved that only the dollar amounts of gifts were intended and that the public policy arguments regarding the adjustment clause were without merit.   As such, the Tax Court validated use of defined value formula gifts as an estate planning technique for reducing exposure to later valuation adjustments by the IRS.  This case was a big win for the Wandrys and for taxpayers and estate planners around the country.

If you need help with your estate plan or would like to learn more, please do not hesitate to contact us at (404) 255-7400.