Dedon on Estate Planning

Fundamental Estate Planning

This summer may be remembered for the unusually large number of high profile deaths. These deaths cause us to face our own mortality and, for estate planning lawyers, result in more phone calls. It is always surprising how many individuals don't have any planning, such as Wills, Powers of Attorney and Medical Directives. Even fewer people have the appropriate planning, such as Revocable Trusts for probate avoidance or correct beneficiary designations on assets and proper asset titling.

With this in mind, by clicking Download Fundamental Estate Pl Presentation 8-31-09 blog.PPT you can follow a PowerPoint Presentation I will be giving this fall to prospective clients and professionals covering the need for fundamental estate planning, the necessary planning tools to utilize, and the critical importance of examining the ownership of the assets and beneficiary designations. The Case Study in the PowerPoint highlights this latter point.

Estate Planning Presentation for Financial Institution and Their Clients

Attached is a PowerPoint presentation I recently gave to a financial institution pertaining to fundamental estate planning issues for their clients.

Download Financial Inst Presentation

Getting Started

A common question is "what do I need to bring with me to our first appointment?" My video, which you can access on YouTube, will provide an overview of the issues we will discuss when we meet.

In addition, funding Revocable Trusts for probate avoidance and to balance the assets for estate tax purposes often is an important part of the planning. Although a list of assets is not necessary for our first meeting, ultimately it will be important to review the assets’ value and ownership. Therefore, assuming you are married, you may prepare a financial statement listing across the top of the page these three types of ownership:

Mr.                 Mrs.                 Joint

Listed down the page will be the assets by general categories. Almost all clients will have real estate (one or more homes); retirement assets (IRA, 401(k), etc); other liquid assets (stocks, mutual funds, bank accounts) and life insurance. In addition, there may be closely held business interests or investment properties.

Taking Care of Basics: Revocable Trust FAQs

With the end of the year approaching, it is appropriate to revisit a basic but yet important and neglected concept central to estate planning: the need to fund your Revocable Trust to avoid probate and, in the case of a married couple, to balance out the estates for tax purposes. The March 31 Post, reprinted below, discussed this funding in more detail. In addition to the guidance provided in the March 31 Post, set forth are common questions clients ask regarding how to transfer assets into their Trusts.

2009 Annual Exclusion Gift

The IRS has provided an early Christmas present by announcing that the 2009 annual exclusion gift is $13,000. It increases from $12,000, which was the amount in 2008. The annual exclusion gift is the amount that you can give to any recipient of your choice during the calendar year without tax consequence. If the gift is a present interest and qualifies for the annual exclusion, it does not erode the exemption amount available upon death. As has been widely reported, the exemption amount in 2009 increases from $2 million to $3.5 million.

For example, in 2009, if husband and wife have two children, in 2009 they can give $26,000 to each child. Upon their deaths, if they have done the appropriate planning, they could still leave $7 million to their children without any federal estate tax. (State estate tax may differ.) There generally is no reporting regarding the annual exclusion. However, there are exceptions depending on the type of gift and who is making the gift.

Designing Trusts For Children

A critical issue parents wrestle with in designing Trusts for their children upon their deaths is how to balance providing the necessary resources for their children against providing "too much too soon" and thereby undermining each child’s motivation to lead a productive and meaningful life. My July 28th Post, reprinted below for your convenience, describes how "ascertainable standards" are the typical provisions utilized to achieve this balance. The ascertainable standards are "health, maintenance, support and education." These words are well understood in the Trust world and in the eyes of the IRS. They provide guidance to Trustees to accomplish the parents’ objective to protect the child with adequate resources but not sap the child’s incentive.

Some clients go beyond ascertainable standards by providing specific guidance that condition distributions on various targets, such as achieving a level of education or income, or marrying, or pursuing a particular profession. These "Incentive Trusts" strike some as trying to "rule from the grave," while for others they merely provide the necessary structure and guidance to help the child when they no longer are able.

Monitoring Tax Exempts

The November 21, 2008 Daily Tax Report published by BNA, reported on IRS Commissioner Steve Miller’s comments at the annual Western Conference on Tax Exempt Organizations held in Los Angeles on November 20^th.  Miller’s theme was full disclosure and transparency regarding tax exempt organizations’ operations.

According to Commissioner Miller, the revised Form 990, which is the annual tax return filed by tax exempt organizations, and greater information required at the creation of the organization, as required by Form 1023, will facilitate the IRS monitoring these organizations. Miller was quoted as saying "[w]e intend to let the sun shine" on governance issues. Thus, it will become increasingly important to have the board of directors actively review key decisions and document those decisions in Minutes.

The Daily Tax Report quoted Miller as saying the IRS will focus on the following:

• The composition and independence of the board

• Internal financial controls

• Compensation

• Conflict of Interest policies

Planned Giving: The 2008 Charitable Remainder Annuity Trust

The November/December issue of Advancing Philanthropy, the bimonthly magazine dedicated to ideas and strategies pertaining to fundraising which is published by the Association of Fundraising Professionals, contains an article I wrote regarding Charitable Remainder Annuity Trusts combined with life insurance. As charities struggle to maintain gift levels, the article illustrates how CRAT's can help charity and the individual. The article contains case studies applying the concept to particular client situations. It is reproduced here.  (It will take a minute to download.)

Possible Estate Tax Changes

At long last the election is one day away. The barrage of advertising, phone calls and mailings will stop and we will have a new President in 2009. What does that mean for estate planning? I have written in the past that both candidates believe change is necessary. In 2009, the exemption automatically rises to $3.5 million. There is no estate tax for one year, 2010 (although there would be no step up in basis for income tax purposes), and then in 2011 the estate tax exemption reverts to only $1 million.

The candidates realize this law is flawed and needs to be fixed. Obama is on record as saying a $3.5 million exemption amount is appropriate. McCain favors a $5 million exemption amount and lower tax rates. With Democrats expected to pick up seats in both the Senate and the House, and in this financial environment, who knows what the amount turns out to be.

Aside from the exemption amount, however, a major change may be the issue of "portability." Under current law, in 2009 when exemption amounts are $3.5 million, a husband and wife do not automatically receive the benefit of protecting $7 million from estate tax. If all of the assets go directly to the surviving spouse by Will, title or beneficiary designation, the surviving spouse, at the second death, is only able to protect one exemption amount.

E.g., husband has $3.5 million and wife has $3.5 million. Husband dies and all assets are now owned by his spouse. There is no tax at his death but at her death she has $7 million of assets and only one $3.5 million exemption amount. Thus, there is over $1.5 million of tax to pay.

If, however, the husband’s exemption was "portable," even though all of his assets went to his spouse at his death, she would still receive the benefit of $7 million of estate tax protection at the second death. Now, since there is no portability, a married couple only receives the benefit of both exemption amounts if assets are transferred into a credit trust at the first death and the couple’s assets are properly arranged. If there was portability, the major inconvenience and complication of changing titles and beneficiary designations would be avoided.

Although increasing exemption amounts would be a major benefit for affluent individuals, a step that would be just as important and could help even more married couples would be if exemption amounts were portable.

Looking For The Silver Lining In Economic Clouds: Family Partnerships and Marketable Securities

As bad as our balance sheets appear in these dire times, if we strain we can try to find the silver lining. A possible silver lining is for parents and grandparents who are considering generational transfers to reduce their taxable estates. They can take advantage of hard economic times by removing marketable securities from their taxable estates. The combination of low stock values, and market and minority discounts resulting from using family limited partnerships (FLP), can result in substantial estate tax savings.

Granted, many taxpayers who previously considered gifts to reduce their taxable estates are no longer concerned or at least do not view it as a priority. On the other hand, the depressed stock market presents a unique opportunity to make current gifts and save significant gift and estate taxes. Therefore, if the estate is still substantial, now is the time to gift marketable securities.

I have previously written about GRATs. Another tried and true transfer tool with a long history is the FLP. In an FLP, the senior generation typically contributes the bulk of the assets and retains control as the general partners. (The general partnership interests are analogous to voting stock of a corporation.) They gift limited partnership interests to children and grandchildren. These limited partnership interests, which represent equity in the FLP, do not have any voting rights. The absence of voting rights and control often result in discounted asset values for estate and gift purposes.

Taxpayers and the IRS have had many battles regarding whether FLP’s can be used to reduce estate taxes, either by lifetime gifts or upon death. Broadly stated, taxpayers assert FLP restrictions prohibiting limited partners from freely selling or controlling the FLP assets significantly depress the value of the limited partnership interests, and hence the partnership assets. These "market and minority" discounts typically reduce the partnership asset values anywhere between 20% and 50%, depending on the type of asset, income generated from the asset, and other factors. The IRS’ positions are varied: they include 1) there is no business purpose for the FLP, rather it is only a device to artificially reduce gift and estate taxes; 2) purported transfers were illusory because the transferors retained indirect control; 3) the formalities were not observed, such as FLP bank accounts were not opened, capital accounts, schedules, and tax returns were not prepared; 4) pro rata distributions to the partners were not made; 5) the discounts were too high, and on and on.

Notwithstanding these IRS assaults, FLP’s are still a valid planning tool if created properly and implemented appropriately. A recent case, Holman v. Commissioner, 130 T.C. No. 12 (May 27, 2008), supports FLP’s to reduce gift taxes even if the FLP consists only of marketable securities. In Holman, the taxpayer contributed solely Dell Computer stock. The Tax Court rejected the 49.25% discount claimed by the Holman’s for the gift of limited partnership interests to their children. However, the Tax Court did allow discounts exceeding 20%, simply because the Holman’s used an FLP to gift limited partnership interests rather than gift the Dell stock directly. The Tax Court rejected the IRS’ position that the transfers were indirect transfers of the Dell stock and the FLP should be disregarded. The Court also disagreed with the IRS position that Internal Revenue Code Section 2703 trumps the FLP agreement and treats limited partnership interests as freely transferable, thereby eliminating any market and minority discounts.

What does Holman mean to taxpayers seeking to reduce gift and estate tax? Consider this example:

Mr. and Mrs. Taxpayer have marketable securities that were worth $12 million in 2006. In 2008, their portfolio fell 25% to $9 million. They want to gift roughly 1/3 of the $9 million portfolio to their children. They first create an FLP, next they contribute the marketable securities to the FLP, and then they gift FLP limited partnership interests to their children. They obtain an appraisal which discounts the limited partnership interests by 31%, so that the FLP assets are worth $6,210,000. They gift 30% of their FLP limited partnership interest to their children, which is worth only $1,863,000 for tax purposes. The underlying asset value, however, is $2.7 million. If the assets bounce back to $12 million, they have removed $3.6 million from their estates. By taking advantage of the FLP and discounts, the estate tax savings based on a $9 million valuation is almost $400,000 (tax savings on a transfer of $1,863,000 instead of $2.7 million). If the portfolio bounces back to $12 million, the estate tax savings are approximately $800,000 (tax savings on a transfer of $1,863,000 instead of $3.6 million). These savings do not take into account the future appreciation also removed from the estate.

In sum, FLP’s satisfy a number of advantages. They can provide asset protection for assets inside the FLP; they can maintain assets for future generations by providing a management structure; and as discussed above, FLP’s provide significant estate tax savings for individuals seeking estate tax relief without losing complete control over the assets.