Tag Archives: estate planning

overview of estate planning, including tax lawes, life insurance, persoanal planning choices, to do list of actions and related matters

Keeping perspective while the debt ceiling “crisis” continues ….

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While Congress and the President continue the political battle on the “debt crisis,” here is more for proper perspective:

First, the yield on Treasuries if falling, not rising. If there were a serious issue about the US ability to repay, then US bonds would see high rates. That is, unlike Greece, which is in real trouble, or even Spain or Portugal, the US is still able to borrow at very favorable rates. So, the markets in general, up to this point, believe that the “crisis” has nothing to do with the economy or the strength of the US relative to other nations.

Second, the debt issues have come about after the extended bull market ended in 2008. That is, high stock values and prosperous markets yielded high tax revenues. With this, there were years of budget surpluses, even after tax cuts were enacted. But, post 2008, that has changed. The change in the economy and stock values, even with some markets approaching their 2008 high points, has led to much lower tax revenues.

Finally, from Floyd Norris in the New York Times, we have this summary:

“If rationality does prevail, the debt ceiling will be raised. For that matter, there is no good reason to have a debt ceiling other than to give politicians a chance to grandstand. The important decisions for Congress and the White House concern spending and taxing. Borrowing, or paying back debt as happened for a couple of years before the Bush tax cuts, is a result of the interplay of those decisions and the state of the economy.”
And
“There is a risk that many analysts now are making the opposite mistake. Deficits have skyrocketed in recent years for reasons that are clearly temporary, or that will be temporary if the economy recovers. In some of the debate, the short-term problems are mixed up with longer-term demographic concerns caused by the aging and retirement of the baby boomers and the rising costs of Medicare, the health insurance program for Americans over the age of 65.”

So, with fingers crossed for the prevailing of rationality soon, that is my update. Let me know if you have questions or comments

Financial impact of the budget plan and planning for tax reform

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First, the on-going budget battle in Washington, or “the debt ceiling crisis,” should be kept in perspective. The battle is more a game of chicken, where one side will eventually blink and the ceiling increased. This political battle is not likely to have an impact on investments, as the markets have already accounted for the outcome, as usually happens well before the event. In fact, by way of example, this is much like 1989 when the municipal bonds of the Commonwealth of Massachusetts we downgraded to a rating just above that for Louisiana. Many investors panicked. However, the underlying economy had not changed. Therefore, the smart investment strategy at the time was to buy Massachusetts bonds. After Governor Weld came to office, the rating went back up and investors who held or bought the bonds had a nice profit. The equivalent today would be to buy treasuries.

Second, as it is shaping up, the deficit reduction package contains major tax reform provisions as well as huge spending cuts. This could ultimately be good for the economy and our markets, as it would bring corporate tax rates in line with other countries, falling in the 23 to 29% range. However, the base would be broadened, possibly including depreciation over longer periods, eliminating deductions for domestic production and trimming or dropping the R&D credit.
The tax overhaul raises substantial revenue, $1 trillion over 10 years. However, this less than half the amount that would have been raised by simply letting the Bush tax expire as scheduled.

New Tax Law: Many specifics will not be known until a new tax law is enacted, which is not likely to occur this year. What Kiplinger’s Tax Letter and others are predicting the following: Instead of six tax rates or brackets, with the highest at 35%, three are expected: one in the 8 to 12% range, the next in the 14 to 22% range, and the in the last in the 23 to 29% range. The Alternative Minimum Tax (“AMT”) would be repealed. The earned income credit and child credit would remain.

To do all this, there will be pain: itemized deductions would be significantly reformed, changing home interest and property tax deductions as well as charitable deductions. For example, deduction of interest might be limited to a mortgage of $500,000 used to purchase a home, but not any for a second home. In addition, the deduction of equity line of credit interest may be eliminated (no one knows what will be grandfathered, so better to have a line in place than to wait). Higher bracket taxpayers may see the deductions converted into a 12% credit.
Something of a surprise, given the push over the last ten years or more to increase personal savings, the deductions for retirement contributions may be cut back, lowering the ceiling and amount of the contributions that will be allowed for 401(k), IRA, Keogh, SEP-IRAs, profit-sharing plans and so on. Similarly, flex plan and health savings accounts may be curtailed or repealed.

We will continue to monitor the information on tax reform, and post updates when appropriate.

Any changes that are this sweeping will require serious tax planning, so that should be on your “to do” list for this fall!

New Estate Planning Pitfalls – Need for careful planning and follow-through

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The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 gives us a two year window for significant estate tax planning, ending December 31, 2012. However, this comes with some serious planning issues. Here are two:

One pitfall of the new law: The new portable credit requires a proactive election by the executor at the first death. Like the frequent failure to make proper QTIP and GST allocation elections, this is an area subject to risks. For example, if the assets are in trust, the survivors may choose not to appoint an executor, missing the opportunity to save the unused credit for the second death.

Also, the portable exemption amount only applies to the unused exemption from the last spouse. For multiple marriages, only the most recent spouse’s amount is available. In addition, an election must be made in the estate of the first spouse to die to preserve the unused exemption and allow for its use by the last deceased spouse.

Second, old trusts that had too much going to the credit portion, the beneficiaries of which are not your spouse, then he or she could be left with very little from your estate.

Please see Estate Planning Overview for definitions and tax impacts, and “to do” list.

Estate Planning – Techniques for Reducing Taxes in Large Estates

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The change in the tax law from the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 gives us a two year window for significant estate tax planning, ending December 31, 2012.

Instead of a $1 million lifetime cap, you can now gift up to $5 million. When your spouse joins in, a major amount of wealth can be transferred. This makes it important to act now, because the law could change in for 2013.

Leveraged Gifting – you can use a defective irrevocable trust (the defective grantor trust is discussed below) to fund an installment purchase of assets from you to the trust over time. The trust is “defective” so that there is no taxable transaction and no gain; it is as if you are selling to yourself. With the installment sale, a note is used and has to bear interest at the IRS mandated rates, the lowest rate of interest allowed. The goal is to repay the note using appreciated assets, where the transfer back to you is also not taxed, and complete the repayment before you die. If it is not completed, the note is an asset taxable in your estate.

Dynasty Trust – you can use the increased generation skipping transfer tax (GST) to pass more to grandchildren and future generations. Again, the new limits allow you to pass far more on to future generations.

Life Insurance Trust – an irrevocable trust that holds insurance for whatever purpose you design, while be excluded from your taxable estate. Your trustee would purchase insurance on your life. The risks of this alternative are that it is irrevocable and that the cost of the permanent insurance is very high.

Second-to-die Life Insurance – a trust that purchases second-to-die life insurance crates a source to pay estate taxes while not increasing the taxable estate.

GRAT – Another alternative is the grantor retained annuity trust (“GRAT”), which uses some portion of your unified credit as a window through which to pass assets at a discount created by the IRS tables that tell us what the asset gifted will be worth at the end of the term of the trust. You receive annuity payments during the term and the principal passes to your children at the end of the term. (This is why it must be funded with “excess” wealth – if you give the trust a term of 20 years but live many years thereafter, there will be many years during which you have foregone the benefit of the assets gifted). The expectation is that the principal will actually be worth more than the amount you gift to the trust, with such increased value escaping estate taxes. Under the new law, there are no GRAT or value limitations.

Cautions: First, the securities laws will treat you as the owner of trust assets for any restrictions on dealing with publicly traded stock. Second, if you die before the end of the term, assets revert to your estate and the structure collapses to look as if nothing was done. Last, a twist: if you stipulate that the trust will not terminate at your death, you substantially reduce the amount that gets thrown back to your estate, reducing the risk of not living through the term of the trust.

Tax inclusive and exclusive – the Sam Walton strategy can used when you want to transfer more than your unified credit alone will allow. If you make a taxable gift, it is tax exclusive (the tax comes from other assets). Thus, the tax is calculated as a percent of the gift. If you die owning the asset and it then passes to your children, it is tax inclusive as the tax is calculated as the total amount, so less of the assets pass to your children. QPRT – The qualified personal residence trust (“QPRT”) uses the unified credit and discount of a future value like the GRAT but applies it to your residence. Thus, both the benefits and risks are similar; it is the asset that differs.

“Defective” grantor trust – The “defective” grantor trust is effective for gift tax purposes and “defective” for income tax purposes so that assets are not included in your estate and yet you pay the tax on their appreciation. Paying the income taxes without any gift tax cost effectively gives away additional wealth. Again, you can leverage this with an installment sale.

Family Limited Partnership – the family limited partnership (“FLP”) is a partnership that you form, acting as the general partners and the limited partners. You transfer assets into the FLP such as any commercial real estate or your shares in your company. When this is complete, you can gift limited partnership interests to your children. Because only the general partners have any say in the management of the FLP, the IRS allows for a discount to the value of the limited partners interest. This discount is 35 to 40%, so more is passed to children without using up your unified credit. Unlike the other alternatives delineated below, when you transfer limited partner interests, your children receive the benefit now. In addition, you have the burden of tax returns for the FLP, as well as tax liability for children who may not receive distributions from the FLP to cover the taxes.

Charitable Remainder Trust – This charitable remainder trust (“CRT”) is a trust that pays a fixed annuity to you and then distributes the remaining principal to charities. You get a gift charitable deduction for the net present value of the future distribution to charities.

Charitable Lead Annuity Trust – This reverses the CRT, where a trust that pays a fixed annuity to charities selected by its trustees and then returns the remaining principal to you or to your estate. You get a gift tax deduction for the actuarial value of the annuity payments to charities or an estate tax charitable deduction.

Caution – you have an investment risk in each vehicle, where failing to generate the larger principal value in the future that you count on to use the strategy will frustrate its purposes. This is the risk of selecting assets that are expected to soar in value but instead collapse. Therefore, none of these alternatives should be considered until you are comfortable that you have “excess” wealth to pass to your children or to a charity and comfortable that you can make a commitment to do so that cannot be reversed. If you say “no” out of lack of comfort or confidence in any strategy, then you will want to stick to a basic plan for now.

What about the Future? Most observers expect the $5 million exemption to stay, along with the 35% estate tax rate. The exemption could be lower, or the rate increased. All of this is reason to review the ideas below and then update your estate plan.

Please see Estate Planning.

Estate tax update

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As anticipated, Congress lifted the estate tax credit for 2011 from $1 million to $5 million, lowering the rate from 55% to 35%. Also, the date-of-death value again serves as the basis for estate assets. Also, the exemption is portable, viz. the un-used portion can be carried cover gifts by or the estate of the surviving spouse. Finally, the exemption will be indexed for inflation. (Estates can elect to use the 2010 rules for $1.3 million carry over basis for heirs).

There are some special rules: up to $1,020,000 of real property used for farming or business can get a discounted valuation; and when a closely held business comprises more than 35% of an estate, then as much as $476,000 of estate taxes can be deferred at a cost of 2% (charged by theirs).

In 2013, the exemption again falls back to $1 million and the rate goes back up to 55%, unless Congress again takes action.

For any 2010 estates, the retroactive action provides requires estates with a date-of-death valuation in excess of $1.3 million to file informational returns to report the carry over basis to the IRS and to heirs (as well as the $3 million for assets passing to a surviving spouse).

See more at Estate Planning.

(or contact us with your questions at Contact Us.)