Dedon on Estate Planning

Estate Planning for U.S. and Non-U.S. Citizens

Attached is a the PowerPoint for a May 22, 2013 seminar I presented at the World Bank, pertaining to estate planning, and the issues affecting U.S. citizens and residents, non-residents, and G-4 Visa holders.

Download Est pl seminar 5-22-13

ObamaCare and Mid-Size Businesses

Attached is an article that appeared recently in Virginia Business Magazine, pertaining to the new health care law (i.e., "ObamaCare"), in which I am quoted. It covers the difficulty mid-sized employers will have come 2014 complying with the new law’s costs as they compete with companies employing less than 50 employees.

Download Va bus mag 4-26-13

ESPN Reports on Charitable Abuse

The March 31 ESPN Website, reported on an "Outside the Lines" investigation of 115 charities founded by high-profile, top-earning male and female athletes. The investigation's conclusion: "most of the charities don't measure up to what charity experts would say is an efficient, effective use of money."

Using the charitable income and estate tax laws to attain undeserved tax advantages is not limited to athletes. There are important reasons why tax policy encourages individuals to give to charities and thereby reduce the government's role to support the poor, and provide support to education, scientific, health and other worthy charitable purposes. But these public policy reasons are subverted when the charitable laws are ignored. Often times the failure to comply with the law exists when high net worth individuals create private foundations, as was the case in most of the scenarios described in the Outside the Lines investigation.

What are the typical problems?

--Foundations are required to distribute a percentage of their assets each year, typically 5%. Often, no money is distributed.

--Individuals working for Foundations are entitled to a fair salary. However, often salary is excessive and little or no services are performed. Not surprisingly, the "employees" are often friends and family.

The moral of the story: don't create and fund foundations (or other charities, such as donor advised funds or supporting organizations) without a true charitable intent. Further, even with the appropriate charitable intent, rely on legal and accounting help to ensure the charity is operated properly.

The failure to properly utilize the Foundation will result in public embarrassment, loss of tax exempt status, and civil and even criminal penalties.

Time to File Gift Tax Returns

In the March 22, 2013, Wall Street Journal, an article captioned "Gift Taxes: What Your CPA Doesn’t Know," described the necessity of filing a gift tax return for taxpayers who made gifts in 2012. 2012 gift tax returns apply to gifts exceeding $13,000. Many taxpayers transferred assets worth much more than $13,000 to take advantage of a $5 million exemption amount. The Wall Street Journal Article explains why it is important to have a qualified CPA prepare the return. What the Article did not discuss, was the importance of satisfying "adequate disclosure," if the gift included non-marketable assets, such as closely held stock or real estate. Absent adequate disclosure, the gift tax return does not start the three year statute of limitations.

As background, if the gift tax return is not filed or if the gift is not properly reported, the IRS can adjust the gift value, even upon the taxpayer’s death on the estate tax return. On the other hand, if the gift tax return is filed properly, then the statute of limitations starts to run. The IRS would only have three years from the later of the gift tax return filing date or return due date to question the value. If the IRS does not audit the return within this three year period, then the gift value cannot subsequently be challenged.

The statute of limitations commences only if the gift tax return is filed reporting the gift, and the gift is reported with adequate disclosure. The heart of the issue is what constitutes adequate disclosure? The applicable Internal Revenue Code section is 6501(c)(9), and Treasury Regulation section 301.6501(c)-1(f). The law applies to all gift tax returns filed after December 3, 1999. The "adequate disclosure" standard is satisfied if the gift is reported in a manner that adequately apprises the IRS of the gift and how the gift value was determined.

There are two primary methods described in the IRS regulations that taxpayers can utilize to meet this standard. The preferred method, and the method recommended by virtually all advisors, is to obtain a "qualified appraisal." A qualified appraisal would include the following:

1. The appraiser's qualifications to make appraisals of the type of property involved, the date on which the property was appraised, and the purpose of the appraisal. The appraiser must hold himself out to the public or perform appraisals on a regular basis and must not be the donor, the donee, a member of the family of either, or an employee of any of such persons.

2. A description of the property and the date of the gift.

3. A description of the appraisal process employed.

4. A description of the assumptions, conditions, etc. that affect the analyses, opinions, and conclusions.

5. The information considered (and if a business is involved, all financial data used sufficiently detailed so another can replicate the process).

6. The appraisal procedures followed and the reasoning supporting the analyses, opinions, and conclusions.

7. The valuation method used, the rationale for the valuation method, and the procedure for determining the fair market value of the property.

8. The specific basis for the valuation, such as comparable sales, asset-based approaches, and merger-acquisition transactions, etc.

The second method does not involve a qualified appraisal. Often taxpayers balk at the cost of an appraisal, particularly for operating businesses or several properties. In lieu of an appraisal, this second method requires a detailed description of the manner used to determine the gifted property’s value. This detailed description method would include:

1. The financial data (for example, balance sheets) used.

2. Any restrictions on stock transfers that were considered, such as would be found in a shareholders agreement.

3. A description of any discounts claimed, such as discounts for lack of a market or control.

4. Assuming there were discounts claimed, a statement regarding the fair market value of 100 percent of the entity.

5. If the entity being valued owns an interest in a nonactively traded entity, all information regarding that other entity must also be provided if that information is relevant and material in determining the value of the interest in that other entity.

Thus, with or without an appraisal, much information is necessary. With the 2012 gift tax return due April 15^th, or with extension October 15^th, time is running out to prepare the gift tax return and, if necessary, to satisfy the adequate disclosure requirement.

Type III Supporting Organizations - Now That The Dust Has Settled

Type III Supporting Organizations ("SO"), which are those "operating in connection with" one or more supported organizations, are treated as public charities because they support one or more public charities. ("SO" herein refers exclusively to "Type III Supporting Organizations," there are also Type 1 and Type II supporting organizations, which are outside the scope of this discussion.) As public charities, they enjoy advantages not applicable to private foundations. Because of these advantages, and real and perceived tax abuse, SO's have been subject to much scrutiny over the last 10 or so years.

In the Pension Protection Act of 2006, Congress added restrictions designed to eliminate abuse in utilizing SO’s. Effective December 28, 2012, the IRS issued regulations that add additional restrictions and clarifications. The new provisions are particularly relevant for "non-functionally integrated" SO's - SO's that do not carry out activities that directly perform the functions of the supported organizations.

To qualify, SO's must satisfy several provisions, including 1) a notification requirement, 2) a responsiveness test, 3) an integral part test, and 4) a control analysis.

     1)  The notification requires that the SO provide documents to each of its supported organizations, including a written description of the type and amount of all of the support it provided to each supported organization, its most recent Annual Return (Form 990), and a copy of its governing documents.

Recommendation: The SO should support only one supported public charity.

     2)  The responsiveness test requires a connection between the boards of directors and officers of the SO and its supported organizations that gives each supported organization a significant voice in the investment policies and use of the SO's income and assets.

Recommendation: The SO Board should include one or more members who are Board members or officers of the supported charity.

      3)  A non-functionally integrated SO has the following two components to satisfy the integral part test:

A. The first component requires that the SO distribute an amount to, or for the use of, its supported organizations each year. The "distributable amount" must equal the greater of 85% of the SO’s adjusted gross income or 3.5% of the fair market value of its nonexempt use assets. Administrative expenses, excluding investment management fees, count toward this distribution requirement.

Observation: This distribution provision is a major change from prior law, which required only the 85% adjusted gross income distribution. Now, one prong of the test is similar to distributions required for private foundations, but with a 3.5% minimum distribution rather than a 5% minimum distribution.

B. The second component requires that the SO be "attentive" to the supported organization. Although there are different ways to satisfy this test, the most common will require that the SO provide support that is necessary to avoid the interruption of a substantial program of the supported organization.

Recommendation:  The So should support a program that is either new or at risk of elimination due to budget cuts, that is identified and designed with the direction of the supported organization.

     4)  SO's may not receive contributions from a person who directly or indirectly "controls" the SO. There is more guidance expected from the IRS regarding the definition of control.

Finally, some issues may still arise. For example, prior to 2006 and the IRS’s evolving position, the SO donor could appoint "independent" trustees to serve with him or her. Now, the question of who is "independent" is becoming more restrictive in the IRS’ eyes to include not only family members, but perhaps any trustee appointed by the donor.

Recommendation: If there is a three member board of trustees, including the SO donor, at least one trustee should be from the supported organization, and perhaps the third should be appointed by the supported organization.

Also, since the 2006 Act, the excess benefit transaction rules apply to SO’s, meaning neither the founder nor his family can benefit from grants, loans, compensation or "similar payment." Thus, unlike private foundations, where reasonable compensation can be paid to family members, SO’s should not pay compensation to the donor or his family members, nor to substantial contributors.

When all is said and done, SO’s remain viable planning tools for donors and charities to enhance charitable giving.